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Opalesque Futures Intelligence

Hamer Trading Talks Managed Futures Strategy: A candid interview with Commodity Trading Advisor (CTA) Jim Hamer about market wizards and managed futures strategies. An "equity guy" turns to managed futures.

Tuesday, March 20, 2012

Hamer Trading is an algorithmic trend follower operated by Jim Hamer, who graduated from West Virginia University. Jim worked in the family hardwood lumber business initially (in West Virgnia) running sawmills before moving to Chicago to trade in the S&P 500 pit in the late 1980's. He became interested in trading systems in the 1990's and subscribed to Futures Truth Magazine, which tracked publicly offered trading systems. Also in the 1990's he begin experimenting with backtesting trading systems using Tradestation, and then he was mentored under industry legend and Market Wizard Ed Seykota in 1997. ƒβ€š‚ A year later he became a registered CTA in 1998, where he operates the investment program and lives in Williamsburg, VA. In addition to operating an independent managed futures program, his other interests include flying, where he is an instrument rated pilot with 2000 hrs and enjoys flying a Cirrus (parachute equipped plane

OFI: I am with Jim Hamer, who is going to provide insight into his managed futures investment programs, focusing on risk management first. Jim has been in the industry for quite some time and has a pretty decent background through a number of different market environments. Going to want to talk to Jim about the overall market environments he has experienced and how his formulas operate through different market environments.
Start by giving us an overview of how you entered the managed futures business? What was that light bulb that went off in your head that said, wow, I want to be a managed futures fund manager?

Jim Hamer: It's funny because I started trading when I turned 21. My grandfather had left a little bit of money to me and I started reviewing the results of the portfolio and what the managers had done and it was awful.ƒβ€š‚  Granted, this was in the early 80's and we had just experienced several years of double digit inflation combined with double digit unemployment, so it was a difficult time for money managers.

OFI: When you say managers, what managers in specific are you referring to?
Jim Hamer: They were portfolio managers at a regional brokerage firm.

OFI: Okay, equity guys, let us make the distinction between equity investing and managed futures investing, because there are two very distinct methods of doing things.
Jim Hamer: No question. Well, anyway that is probably a little further back than you want to know. Anyway, they were doing poorly and I thought that since I wasƒβ€š‚ ƒβ€š‚  nearly a college graduate, I could do a better job.ƒβ€š‚  It's funny looking back now.ƒβ€š‚  So, I started managing the money myself.ƒβ€š‚  I started studying and learning about the markets.ƒβ€š‚  I began reading The Wall Street Journal, I added an investment class to my schedule, and began talking to my hometown stockbroker about how we could do a better job on these investments. Like any good stock broker, he suggested I buy more of the stocks I already had, I asked how - and he introduced me to margin!ƒβ€š‚  The S&P 500 was about 116 at that time (April 1982), it made a long term bottom within a few months of this date. I thought I was a genius, because the S&P doubled within three years and so did my money.ƒβ€š‚  It seemed easy.
OFI: Let's be careful about the performance claims, especially when we are talk about doubling money.

Jim Hamer: Well, you missed my punch line. I doubled the money and then some, but by October of 1987, I was so leveraged, that I nearly lost it all in the crash, so that was my first lesson about risk and my introduction to futures trading.ƒβ€š‚  At the same time I was learning about using margin for stock purchases, I also had discovered the S&P 500 Index futures contract.ƒβ€š‚  I could get a lot more leverage than typical stock margin, so I began buying those contracts as well in addition to my margined stock portfolio.ƒβ€š‚  The bottom line was that I did not have risk control and that was my first introduction to the world of investing and trading, and it taught me that I really did not know how to trade - and that risk was real and that leverage could hurt you. So, that was my introduction.

OFI: Great introduction.
Jim Hamer: And if you read Market Wizards, which was a very influential book to me, it seems that many guys had similar experiences when they first got into it.ƒβ€š‚  They had some interest in the markets and were attracted by the quick money, then they got "leveled", and then they decided to learn the right way to do things. So --
OFI: Okay, so go into the right way, where is that line between the right way and the way you learned early in your career?

Jim Hamer: Well, I had no risk control, I was buying as much as I could, as much as the leverage would allow me to buy, and I had no stop points, I had no systematic way of sizing of positions that we do now. I mean all of the things that I learned under my mentor, Ed Seykota in 1997.ƒβ€š‚  So, even after this terrible experience of 1987, I still was very interested in learning to trade. I decided that I needed to go to Chicago to trade in the pits.

OFI: Which pit were you in?
Jim Hamer: I was in the S&P pit in 1988 and trying to scalpƒβ€š‚  as a local and figure out how to trade the S&P 500. I was not very successful - I would make a little bit of money one day and lose most of it the next day, I might have made enough to pay the lease (800/mo) but not much else.ƒβ€š‚  That's when I began studying systematic trading systems. Back then, I began a subscription to a publication named Futures Truth published out of North Carolina.ƒβ€š‚  They ranked publicly offered trading systems based on their real time performance since inception. I liked this approach, it had history to lean on and it took some of the emotion out of trading.ƒβ€š‚ ƒβ€š‚  I decided to leave Chicago and return to my family's lumber business, but I spent any spare time I had reading about and analyzing trading systems and I purchased "Tradestation" and began doing my own testing.
All of the good systems had good risk control - a finite amount on each trade.ƒβ€š‚  They all had predetermined entries and exits.ƒβ€š‚  As I began studying those systems, I also read the book, "Market Wizards," and I had read about Ed Seykota - and that he was a systematic trader.ƒβ€š‚  I read that he had actually worked with other traders from time to time to help them, and to train them. And this is 1996 now.ƒβ€š‚  So, I decided to call him up and I asked him if he would be willing to train me.
After a period of time of correspondence, he eventually agreed and I got to go to Incline Village, NV in 1997 and lived with him for a couple of months.ƒβ€š‚  He began teaching me trend following methodologies, but more importantly, how to back test a strategy over years of price data, how to size positions, and what your risk control is on a portfolio. When I left his training, I began trading full time and became a Commodity Trading Advisor (CTA) the following year (1998).ƒβ€š‚  I first began family money and then other people's money. And that is kind of my evolution of getting into the trading business.

OFI: Aren't there other traders that live in the Incline Village area?.
Jim Hamer:ƒβ€š‚  I believe Michael Milken (junk bond king) lives down the street from Ed.ƒβ€š‚ ƒβ€š‚  There may be other traders that I am not aware of.

OFI: So continue your story, because that is fascinating how you got to where you are. I mean a story of risk management, learning professional investing, and then taking a systematic approach. So, kind of, pick up from there, you where in the late 80s, early 90s.
Jim Hamer: Well, as I said earlier, I left Chicago in 1989 andƒβ€š‚  went back to myƒβ€š‚  family lumber business.ƒβ€š‚  My family operates sawmills in West Virginia and we also manufacture wood pellets for residential stoves. I actually went back into that business for several years and that is when I began my study of systematic trading systems and that's when I first purchased Tradestation, a software platform that would allow me to do system testing on my own. That's also when I began reading all I could about futures trading and at that's when I read Market Wizards which was probably one of the most influential books for me getting into the trading business.

OFI: Really, let us talk about your most influential books. Give me a list of the top 3 books in order that had an influence on your career?
Jim Hamer: Well, Market Wizards would be number one. Reminiscences of a Stock Operator, loosely based on the life of Jesse Livermore is certainly number two.ƒβ€š‚  Not sure what number three would be.

OFI: Maybe there is not a number three if you have to think that long, I know I have been in that notions too. My most influential books was Natenberg's Option Volatility and Pricing. I still remember that one. Sorry, go ahead you got to two --
Jim Hamer: Yes, of course Stock Market Wizards introduced me to Ed Seykota, who was my mentor and taught me the fundamentals of systematic trading.ƒβ€š‚  That obviously impacted me the most. Ed didn't really show me exactly how he trades, nor did he try to teach me a particular method to tradeƒβ€š‚  - such as breakouts like the Turtles, or moving average crossovers - which he used early in his career, instead Ed focused on how to test your ideas properly.ƒβ€š‚ 
How to develop a program, how to size risk, etc.ƒβ€š‚  His strongest belief was that longevity was the key through strict risk control because the futures landscape is littered with people who make it big for a while, then "blow up".ƒβ€š‚ ƒβ€š‚  The leverage that is available is great and can be treacherous.

OFI: Exactly, and you can usually tell that when you look at their margin equity ratios. It is fascinating to look at how people margin to equity; it is all over the map with the newcomers.
Jim Hamer: Absolutely. That was the key that he tried to instill in us, just do not put yourself at risk on any one trade and be diligent about risk control. That was my base and, you know, I probably do not have a lot of original ideas, I have read and studied different trading ideas and tried to pick up the things that I thought made sense and that tested well.ƒβ€š‚  Our overall approach to trading as a trend follower is:ƒβ€š‚  I want to participate in any trends that might develop regardless of the sector.
So, we trade seven sectors and 31 markets and we trade a few markets from each sector, because I am not sure when the next trend might develop, whether it is precious metals or it is energy or even in the interest rate sector.

OFI: Now, you are a systematic guy, you have algorithm set and whatever market environments come along they come along, you take those moves, that is interesting.
Jim Hamer: Yes, I do not want to miss a move, so if there is something moving I want to be a part of it. So, that is our approach, we attempt to allocate equally allocate to the seven sectors, although we are a little heavier to the to the interest rate sector than the others.

OFI: Why is that heavy in the interest rate? Is there a strategic reason for that?
Jim Hamer: It seems like there are so many different markets from the short end to the long end that have done well and when we began constructing the portfolio, it seemed to fit.ƒβ€š‚ ƒβ€š‚  Also, we don't always see this sector to be as correlated as some of the other sectors, plus we trade other countries debt that can behave differently than the U.S. markets as we have seen last year.ƒβ€š‚  So, when we looked at it we were saying, okay, well, we are a little heavier there, plus these are very liquid markets and they trend well.

OFI: With the European debt meltdown, it seems like we are going to just sort of a fundamentally different structure in the interest rate complex. I mean it just fascinating to watch, I used to trade on the yield curve, so I kind of have a preference for yield curve issues, I do not know if you are following into the fundamentals, do you keep track of fundamentals at all?
Jim Hamer: I look at them, but I do not let impact my trading decisions.

OFI: Okay, so you are entirely systematic then. Can you tell me a little about your risk controls? How do you manage risk? Do you look at volatility? Is there a timeframe? I would suggest that you might want give investors kind of an idea of how risk is managed and if you can just give people expectations, they have a general idea of how an investment should work.
Jim Hamer: Right, sure. Once we have determined our entry point we immediately have an exit point, and we measure that risk as each trade comes along and we apply a percentage of the portfolio to that particular trade risk, in our case it it's three tenths of one percent (0.3%) for all our entries.

OFI: Interesting, so very risk focused.
Jim Hamer: Yes. Our stops are volatility based stops, so we know where that initial stop is and that is how we size that "bet" or trade.ƒβ€š‚  That also determines the size of our position.ƒβ€š‚  We do this equally for all the markets we trade.ƒβ€š‚  Also, we are fairly long term trend followers.ƒβ€š‚  Our average holding period is 100 days.

OFI: Oh really, okay.
Jim Hamer: What was I going to say, I am sorry, I looked at the screen, the markets are up huge this morning.

OFI: Well, it is interesting. We are going to get these, these bouncy markets are kind of crazy, all the volatility. I quite frankly think it is related to the debt crisis and I mean I have never -- let me ask you this question, here is a good question. Look at the volatility we have see in the markets, you have been in these markets for quite some time, have you ever seen volatility, equity market volatility like this before?
Jim Hamer: Well, of course, going through 2008; yeah, I mean there was pretty tremendous volatility but you are right, it's been volatile in 2011.

OFI: But this is a run up, this is like consistent stock market volatility. I do not know that I have seen -- like 2008 was -- previous to 2008, people started to get a sense of what was going on in the summer and got a little bit of volatility, I have never seen this prolonged kind of volatility.
Jim Hamer: You are right and it has been volatile, and some markets have been pretty tough to trade. Many potential investors have asked us "why are you doing so much better than the trend following CTA indices?" - and the only thing I can attribute it to is that we are longer-trend based and we are not getting shaken out of some of these choppy moves, we leg into trades and are slow to get all the way in, and we are slow to get all the way out.

OFI: Well let us talk about that, because that is actually a point of risk management. I do not know that there is right or wrong answer here, I think it is just a matter of investors understanding. So, essentially, you have got a longer-term model, you could let things run to the downside or to the upside and your stops might not be as tight, so you are going to catch a lot to the upside that way, typically that is your goal, but you are also -- there might be a little bit of drawdown that you have in your stops and investors just need to understand that going into it.
Jim Hamer: Absolutely, and it's funny because I used to talk about that with my mentor, Ed Seykota, he would say, "hard on the stomach, but good on the pocketbook" in reference to giving back open trade equity (profit).

This article was published in Opalesque Futures Intelligence.
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