Kevin Davey is a full time professional trader and systems developer and has been for over 20 years. An aerospace engineer and MBA by background Kevin writes for industry publications such as Futures Magazine and has authored his own book called “Building Winning Algorithmic Trading Systems”.
Kevin won a global futures trading contest in 2006 and placed second in 2005 and 2007. During these competitions he returned between 107% and 148% on a real money account.
In the show Kevin reveals:
- What he uses to pick entry signals
- Why he’s happy with low winning percentage systems
- His unique take on draw down and risk taking
- How he know’s when to kill a system
- The best way he’s found of scaling out of trades
Trade Your Way to Financial Freedom by Van Tharp
Building Winning Algorithmic Trading Systems by Kevin Davey
Platform & Broker
TradeStation for both.
Tell us a bit about you personally and what first attracted you to trading?
I got a direct mail piece in the mail about how you could make millions with no risk. I’m sure everyone has seen an ad like that that’s tried to convince them to get into trading. That and given I was an engineering major and liked numbers and solving problems and that sort of thing. And that just naturally led to solving the market.
That was probably 25 years ago. I was a couple of years out of college.
Can you give the listeners some insight into your trading? Your trading style, strategy, time frames, ave. trade duration, % winner’s, typical risk reward ratio, typical yearly/monthly return, number of instruments you trade, maximum/average number of active trades, typical drawdowns you experience… those sorts of things.
Where I’ve found success is creating mechanical strategies that are all rule based. A lot of them I automate, so I don’t have to place the orders, they’re done for me.
I’ll look at any market, and a whole bunch of time frames. So some of my systems are intraday, some last weeks and some even months that are based on seasonal.
Winning percentages, I don’t even look at that as a metric when I’m going to trade a system. Because in the long run you can still make money with a 20% winning system and you can lose with a 90 and I have ones in that whole range. Probably most of my systems tend to last around 30-35-40% winning rate. That seems to be a common number just talking to a number of other people with trend following type systems.
In terms of what drives the signals, I’ll take anything that works basically. Some of them are traditional technical indicators, e.g. ADX and RSI. Other times I’ll use candlestick patterns and other simple things like Momentum, e.g. if the close is greater than the close of the bar 10 bars ago then buy the next bar. I tend to keep it really simple. The same with exits, and just look for things that tend to persist over time.
Right now I’m trading over 80 systems and about 50 are automated.
What does your typical trading day look like?
Probably spent doing a lot of things that aren’t trading. It sounds kind of weird, but I’ll be here at my desk and usually what I’ll be working on is developing new systems because I’m constantly trying to build new strategies to either improve the ones I’ve got or just have ones ready if the ones I’m currently using break. I have the philosophy that all strategies will eventually stop working at some point. When that happens, two things, I don’t want it to kill my account, so I’m not trading one strategy with 50% of my account, everyone’s a very small portion. And if it doesn’t kill my account I want to have another strategy ready to take its place.
Also during the trading day I’m doing some other research projects. I have a pretty good idea of how I go from trading idea to the final system but I’m always looking at that process to see if I’m really doing it the best way or if there’s a better way to do it, what are some other people using?
How do you determine when you need to kill one of your systems?
I don’t know if I know the best answer to that because there are a lot of different ways you can do it, e.g. if you had a high winning percentage system, if you’re hit with a string of losers that you haven’t had before, historically, that could be a tip off. Another one you can use is draw down. If the historical results of your system say you have a draw down of $10,000 and you hit $15,000, then maybe somethings wrong with the system.
What I do with every system I bring on board, I know when I’m going to stop trading it and usually it’s draw down based. The important thing is that you have that rule, whatever it is for the system, you have it written down before you start trading.
You say “If X happens I’m stopping this system” and what I end up finding while I’m trading in the real world is that if that happens, the system goes off and life goes on. And there’s a lot less emotion with it. The key is not which metric you use to stop but having that metric written down in the first place.
What’s your typical draw down and risk reward ratio?
When I’m looking at a new strategy I like the annual reward to be at least two times the maximum draw down.
Overall on a portfolio level I also look for a two to one ratio. So, basically, at the end of the year if you get a 30% return as long as I had a 15% or less max draw down I’m pretty happy.
In the beginning, what differentiated you from the average “man on the street” trader out there? What traits did you have, what actions did you take? We want to hear your secrets to success.
I probably was that person for at least the first 10 years or so. I made every single possible mistake.
What kept me going those was that the market was this puzzle and I wanted to solve it. I guess, the biggest secret to my success was just not giving up and slowly over time learning how to do things the right way. And how did I know if was the right way? Well, a lot of times when you look at a new system or a new technique you don’t know it’s going to work, even if somebody says “Hey it worked for me”. You don’t really know for sure. Ultimately it’s you who determines your success. You try something and it works and that gives you that positive feedback that says “Hey, you are doing things correctly” and you can push on.
Unfortunately, for most of us, that turns out to be pretty expensive. I look at it as market tuition. I paid a whole lot over the years for market tuition. But finally I came up with a process that fit my background which is more scientific (it’s kind of step by step – here’s how you develop a system, here’s the criteria you use at every step). Once I did that and found that this leads to results where I can make money then I just kept building on that.
You’ve got to keep building on what you’re doing and keep improving because there’s tonnes of people coming in and new trading firms coming in all the time and their goal is to take your money and I think people who stagnate will run in to trouble.
If you were a retail trader working a day job, what 3 steps would you take to start earning an income?
I’ve been trading full time only for about 7-8 years now but I was able to make that jump from part time hobby trader to full time trader.
You’ve got to have a good system down for how you’re going to work on trading, how you’re going to improve trading and that sort of thing.
The next thing, you have to have enough capital. What you think you need you probably need 5-10 times a much to survive in the real world. Because what really happens is you have to draw your living expenses from your trading account and a lot of people don’t really consider that. Back when you’re part time trading that’s not a real concern because you have your salary to draw upon.
The biggest thing is being dedicated enough when you’re doing it part time. That’s the hardest thing. For me it became my only hobby. I’d come home from work and work on trading systems or something trading related. That’s tough because it means you’re excluding other fun activities at the expense of this. But when you think about it you have to do it because you’re up against a lot of professionals who do it full time and they have better resources, more time, PHD’s and staff they probably have more brain power.
Can you explain to the listeners your preferred trading strategy, the ins and outs of how it works and why you choose this type of strategy over others?
Typically, my better trading strategies will follow the rule of let your profits run and cut your losses short.
The method of entry, I’ll use all kinds of entry methods. The thing is when I’m wrong I’ll have a stop in place and I’ll exit. I don’t wait, add onto losers or anything like that.
As far as profits I’m always looking at break even stops, trailing stops and all different kinds of things to protect profit. But by in large, what I find works usually the best is the most psychologically painful and that’s just letting a position run and not locking in any profits until the trade is closed. That might mean I have a couple of thousand dollars profit in a trade and the market might turn against me and that’ll become a losing trade.
My ideal system, the entry doesn’t matter too much and I try and let the winners get as big as they possibly can.
If you split your trading up into technical vs fundamental, what would that split look like?
80/20 with most of it being Technical.
Diving a little deeper, thinking about any price chart, what 3 things would you recommend a novice or intermediate trader educate themselves on when reading a chart
One, looking for spikes. And the reason we want to look for those is if a market is more spiky with either the highs and lows that tells you something with at least some of your stop losses go. Because what happens in some markets it that there’ll be a quick spike up or down and it’ll take out a lot of stop losses but then the market will go back to where it was. So it you’re trying to trade such a market with stop losses you’ve got to be careful. So, there are some markets where I’ll only use stops based on the closing price. So it’s not really a stop order, but I’ll calculate the end of the day if the close is below a certain point I’ll exit at the open of the next bar. That kind of avoids some of those crazy volatility spikes that don’t persist.
The other thing is to just look at a chart and imagine what the price action looks like as you’re going through it. Is it kind of waves? That might suggest you want to do something like a breakout method or something on a retracement of a breakout. That can certainly give you a lot of ideas for an entry.
But what I wouldn’t do, which a lot of people do is put an indicator up and look at a chart of limited time and they’ll make a decision that that’s a good indicator or not. That’s the worst thing. People draw conclusions on really small samples of data. They’ll look at 3 trades that this new indicator would have taken and all were losers to therefore that’s not a good indicator and they toss it out.
You have to look at a lot of data and that kind of fits in with what I do which is test over 5-10 years of data and that gives me enough confidence as to whether I think I have a little edge here of I don’t.
How long did it take you to go from trading newbie to consistently profitable trader?
At least 10 years.
What’s your mental approach to trading and what special techniques do you use to keep your emotions in check?
Going to automated trading and letting the trades happen without me interfering.
What’s your favorite entry setup?
A momentum based entry.
What strategies do you use to exit and manage active trades?
In most cases it’s just a stop loss and a lot of systems I’ll just exit after a certain number of bars go buy.
What’s your recommended “must read” trading book?
Probably the one I wrote. I would say some of Van Tharp’s books, e.g. Trade Your Way to Financial Freedom.
Do you automate parts of your trading? If so, what have you automated, why and how does it help you?
The big thing that helps me is that it makes it so hard to cheat. When you have 5-10 systems and you want to over rule signals, you’ll find that eventually you can’t do it because you won’t remember which systems your following which systems you’re cheating on. It just becomes easier to follow the system.
If there was one thing you would recommend any retail trader spend the next month mastering, what would it be, why and how could they go about mastering it?
It would be to test. To learn how to test an approach and this goes for discretionary traders, mechanical, anything. You want to see if, what you’re doing has some kind of edge and the way you’re doing that is to go back and look at history to see if it would have worked. So get yourself some testing software.
What trading related internet resource, like bloomberg.com, do you always use?
TradeStation Forum or BigMikeTrading.com.
What’s the biggest mistake most retail traders make?
As far as people testing and doing evaluation, they do it the wrong way. They over optimize.
What’s your preferred broker and trading platform?
TradeStation both to do the testing and trading. They’re also a broker.
If there was one mantra or saying our listeners should reminded themselves of each day, to help improve their trading, what would it be?
Just test and evaluate.
If you could leave our listeners with one piece of advice what would it be?
To never stop trying to improve your trading. Just don’t sit on one strategy and thing that’s going to make you a millionaire because it won’t.
We’d like you to help us find a high probability exit point for our trading system. We already have a market to focus on (namely the S&P500), and we’re looking for specific standard indicators, candlestick formations, market events, those sorts of things… what “3 golden nuggets” can you share with us today?
What I would look for in the S&P is if it’s an intra day system it would be as simple as an end of day exit. What I’ve found in some of my systems is when the system goes you your direction it’s probably best just to hold it until the end of the day.
One time you might want to avoid that is the last half hour, forty five minute of the trading day as you tend to get a lot of reversals. Either that or you get where the market just takes off.
So, a good exit there, if you’re going with the trend of the day. If you notice the market changing in the last 45 minutes don’t be afraid to reverse, especially if you test it out that way if it shows it to be better. Because most of the time the market gives back what most of your gains would have been in that last 45 minutes.
The last nugget would be more for the long term system. Just stay in a trade that’s profitable until you get a signal that tells you to go in the opposite direction. So, don’t look to exit at a specific profit, look for unlimited profit until you get a signal that tells you it’s better to go the other way. I use that type of thing with some of my swing trading on the S&P.
All those things I’ve just mention I use to some extent in my own trading.
Before we wrap up, what’s the best way for traders to get hold of you?
You can visit my website kjtradingsystems.com. There’s contact forms on most pages so you can just do that, or you can send me an email directly, that’s kdavey at kjtradingsystems.com.
Have a question for Kevin?
Leave a comment below… I’ll make sure it gets to him.