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Article Lifetime Achievement Award Goes to Chuck LeBeau by Van K. Tharp
Mail Bag Risk Calculation or Profit Factor?
Fine Tune Your Trading Skills
A Tribute to System Development Expert and Dear Friend Chuck LeBeau
Last weekend in Chicago, I had the honor of presenting Chuck LeBeau with a Lifetime Achievement Award for the Traders Hall of Fame.
Briefly, for those who don't recognize his name, Chuck is one of the pioneers in the field of trading systems. He is the co-author of Computer Analysis of the Futures Market (McGraw-Hill, 1991) which is considered to be a classic work in technical analysis. He is a recognized expert in technical analysis and is considered a foremost authority on technical indicators, particularly the Average Directional Index (ADX), Average True Range (ATR) and various exit strategies.
I first met Chuck at an AIQ conference in the late 1980s. I was impressed enough with his work and research to invite him to participate in our first (and only) school for traders in 1992. About that time, I also started giving a workshop on how to develop a winning system that fits you. I did the first few workshops with Tom Basso in 1993-4, but then Chuck took over and taught around 20 of those workshops for us over the years. He still says I’m the only person who ever paid him a fee for speaking—people usually just paid his expenses. When he retired, he told me he’d only speak at our workshops, for which I feel deeply honored. Chuck also wrote a section on Fundamental Analysis for my book, Trade Your Way to Financial Freedom.
Even though I have known Chuck for a long time, I interviewed him about his life and realized that it would make quite the interesting biography, or even a movie.
Introduction to Commodities and Grunt Work
Chuck went to college at Cal State Long Beach as a prelaw major. There were three professors there who had who had been exploring the markets and Chuck took a course from Dr. Charles Harlow on commodities trading. Chuck was one of Harlow’s best students and he was hired by Harlow to copy futures prices from the Wall Street Journal to create bar charts. Long after that job ended, Chuck continued his price recording and charting practice.
Chuck was drafted into the Army in January 1963 and, as a college graduate, he was commissioned as an officer. (I wish I’d known that when I got drafted 5 years later, but that was probably too far into the Vietnam War for me to want to become an officer).
Chuck was assigned as the property book officer for the European Command Center located in Paris. Early on, Chuck’s strong ethics became well known within the command.
Chuck was responsible for signing off on the inventory at the command center. At one point, he was asked by his Sergeant to sign off on some assets without performing a physical check of stock. Chuck’s ethics, however, wouldn’t allow him to just sign on a dotted line without actually seeing the inventory.
Apparently, this caused quite a stir because the unit commander, a full Colonel, called him into his office and immediately reassigned him. (Chuck thinks it’s possible his replacement in that role might still be in jail—millions of dollars worth of equipment were found missing not long after that.)
Chuck’s Colonel reassigned him to a unique position at the American Embassy’s Courier Station, also in Paris. Chuck did his job well and eventually worked his way up to the position of Commanding Office of the courier station. In this role, he was in charge of top-secret US government and military documents. For this job, Chuck wore civilian clothing, carried a hidden firearm, had a diplomatic passport, and got to travel all over Europe on document courier trips–effectively chartering flights. The generals knew Chuck could arrange courier flights at will and they were frequent callers asking him to schedule document transportations that would match their need to go somewhere in Europe.
Personally, I would have stayed at that job for awhile, but Chuck had other plans. In addition, the Vietnam War was heating up. He left the Army and began working for EF Hutton as a commodities specialist. Throughout his Army stint, Chuck had continued collecting commodity data and making charts from the Wall Street Journal price quotes.
Mainframes, Soybeans, and Wheat
Chuck’s EF Hutton office was in Torrance—a top aerospace hub in Southern California. Because he preferred to teach over making cold calls, he held Saturday morning workshops on commodities trading. As a result, he started meeting lots of engineers from the local aerospace companies who had the means and desire to test commodities using mainframe computers. Because of Chuck’s dedication to his personal task of recording and charting commodity prices, he had the data they needed to feed the mainframes.
In 1973, the soybean crop exploded and beans reached a record price of $5—about twice the value of the average price for the previous few years. At that point, everyone seemed to want to short soybeans. Chuck thought something was wrong with that thinking, though, so he got all of his clients to go long. His decision to go long on soybeans proved to be a wise move. Soybeans then went to $12.90. Because of the soybean trade for his clients, Chuck went from 100 small accounts to 100 large accounts and became a top 10 producer at EF Hutton. In those days the commission was about $125—no discount brokerages then.
Chuck was able to return each client’s starting capital (and more), saying that now, no matter what happens, his clients could say they were winners. As far as I (and Chuck) know, he is the only broker ever to be able to say that all of his clients were winners.
A year later, he put his clients in a wheat trade based upon some little understood information that indicated the Russians were going to buy a lot of wheat. Chuck and his clients went long with wheat in a seasonal downtrend. That downtrend continued for awhile and most of his clients lost a lot of money by the time the news came out that the Russians were buying wheat. Although, some of his clients did make big dollars from that eventual outcome. It just goes to show that fundamentals eventually influence price action, eventually (but don’t trade it until you actually see the price move).
Position Sizing Strategies
When Chuck was telling me about catching these big commodity moves, it made me think how close he was to becoming another Ed Seykota. Ed’s primary edge was being one of the first computerized trend followers. Ed also really understood position sizing strategies and actually used a market’s money position sizing method.
When I mentioned that to Chuck, he told me the following story about his first exposure to position sizing strategies. Hutton discovered that they had a lot of “dead” accounts—previously active traders that had just burned out. So they decided to ask a number of these people to re-open their accounts and follow Dave Johnson’s trades. Johnson was an experienced trader in the company with a solid track record.
As this program started out, Dave called one profitable trade after another—five straight winners in a row. The 6th trade, however, lost some money. When Dave put out the 7th trade information, practically nobody in the program took it. Why? Hutton discovered that nearly everyone in the program had been putting their entire account into each position and the last trade had wiped out a lot of them.
After that experience, Johnson started giving lectures at Hutton about risking only a small percentage of your equity on any one trade. Chuck says, in retrospect, that this was his first exposure to position sizing strategies.
A Bubble Bursts
EF Hutton ended up being part of the Hunt Brothers silver trade. The Hunt Brothers amassed nearly one third of world’s stock of silver and in the process sent the price from $6 an ounce in 1979 to over $48 in 1980. When the Hunt Brothers wanted to trade silver quietly, they did it through EF Hutton. That gave Chuck a bit of information about what was happening in the silver market.
At the height of the crisis, the government changed the rules and only allowed people to liquidate silver. Silver went limit down that day immediately. Chuck had his customers in silver at that point as well but had a sense of what was going to happen. That same day, he went into the cash market and got his clients out of their positions at a price about twice the limit down amount. Many of them were furious at Chuck for doing that until they saw spot silver drop about 50% in 4 days and then watched silver futures go limit down for 17 straight days.
After EF Hutton went out of business in 1987, Chuck worked for Paine Webber doing research. He also began talking with David Lucas about doing some research and starting a CTA.
In 1987 there were no platforms for trading research so David wrote the programs to test Chuck’s idea. They first tested moving average crossover combinations—about 26,000 pairs each night until they had tested well over a million combinations. Their conclusion? During trends, many combinations worked well, but all of them gave back their profits during sideways markets. This led David and Chuck to work on how to identify and measure trends.
They spent months studying trending indicators. Unfortunately, they didn’t go about studying these indicators alphabetically. Toward the end of their research, they discovered that the best trend measurement was a rising ADX. When they took the first moving average crossover after a rising ADX, however, they found that they were usually wrong. Moving average crossovers are usually so much faster than the ADX. After some time, they just started entering positions on a rising ADX.
In 1990, Chuck and David formed a CTA with about $100K under management. It grew to $26 million at it peak, which corresponded to the start of a long sideways market in commodities and a subsequent mad rush into equities. So they closed the fund down and Chuck moved into equities research.
Most of their initial research became one of the best books ever published on trading research in my opinion: Computer Analysis of the Futures Market. In addition, they published the Technical Trader’s Bulletin during that period.
Chuck says he would like his legacy to be that BUY AND HOLD DOESN’T WORK. Chuck and I share the experience of buying a stock when we were young, watching it go sky high, and then go to zero.
Chuck also desires to be known for his exits. Back in college, Chuck was given a good entry technique by Dr. Harlow. It got him into positions, but when Chuck asked, “How do I get out?” Dr. Harlow responded, “That’s your problem.” At the time, Chuck got out when his profit was equal to a month’s salary, but Dr. Harlow’s method really got him interested in exits right from the start.
In my view, Chuck’s most significant findings from his research are effective exit strategies. Traders traditionally don’t think about exits that much, but I believe exits are one of the two most important areas for great system performance (position sizing strategies being the other). As far as I’m concerned, Chuck LeBeau is the EXIT KING for the industry. In testament to that fact, Chuck recently created a web site that manages profitable exits for your trading position. It’s so good that several brokerage companies recommend its exits. His site is http://smartstops.net.
Chuck has made a number of enduring contributions to the trading arena. It’s been fantastic working with him and our clients have been unanimous in their praise of his teaching and writings.
I am honored to consider him as one of my closest friends in the trading arena.
Can't Come to the System Development Workshop Next Week?
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Chuck LeBeau – Fun and Fantastic, A Friend Indeed
There’s no better time than this week to pay homage to my good friend and mentor Chuck LeBeau. I have many great memories of working with Chuck and have learned a great many things from him as well. I’d like to share a couple my favorites with you.
Some years back, I found myself teaching a How to Develop a Winning Trading System That Fits You Workshop with Chuck on the weekend of Super Bowl XLIII. I’m pretty sure that was a scheduling oversight on my part as most folks (including yours truly) would rather experience the Super Bowl than be in a workshop.
The workshop was in Phoenix that time, which made it easy for Chuck to drive down because he lives just north of there. As it turned out, Chuck’s beloved Phoenix Cardinals made it to the Super Bowl that year. Having your team play in the Super Bowl on the same weekend that you have to teach, well that was like adding insult to injury for Chuck.
Now, on the first evening of the workshop, we had checked out the local sports bar scene. All were expected to be overflowing with hometown Cardinals fans. At dinner on the second night, Chuck and I ate at the Camelback Resort and inquired with the waiter if they might show the game. Because it’s a five star establishment, we were fully expecting a polite “no” response with a recommendation for a close-by sports bar. To our great delight, the bar area of the superb BLT Steak restaurant was going to bring in a big screen TV and have a Super Bowl party—for the first time ever! They agreed to save us a seat for the next night.
Through some creative scheduling and an early start to the last day of the workshop, we were able to head out of the hotel a little early to watch the game. On the way to watch the game, though, Chuck realized that we had no Cardinals paraphernalia to wear. That would not do. We stopped by several sporting goods stores to find every one of them completely sold out of Cardinals items. Unperturbed, we brainstormed and decided to try a Walgreens. They had only one kind of Cardinals product left in stock—a baseball cap that looked innocuous enough until we discovered a small battery pack and a switch. Flipping the switch turned the wearer into a walking light show with a series of LEDs sewn right into the hat! Despite its tackiness (or honestly, probably because of it), we both bought one and proudly turned on the light show for full effect as we walked into the high end steakhouse. (To see the hat in action, look for the link at the end of the article.)
Well, we had seats waiting for us but it turns out we really didn’t need a reservation. For the first half of the game, the only souls watching were Chuck, me, and two students from the workshop. There were only the four of us in the whole place and we had a staff of six to wait on us! We had amazing food and doting service—it was like having our own private five star Super Bowl party.
And what a game! When Larry Fitzgerald caught a 50+ yard touchdown pass from the ageless Kurt Warner to put the Cardinals ahead late in the game, our table went ecstatic: high fives and fist bumps all around.
Then the Steelers made their famous 4th quarter march down the field capped by the amazing throw from Rothlisberger to Santonio Holmes. Alas, there was no joy in Mudville as the clock ran out. Nevertheless, it was an amazing game and an even more fun and amazing day because I had thoroughly enjoyed Chuck’s company.
Even though we had met 11 years earlier and had been teaching together for almost half that time, I got to know Chuck better than ever the night before at a quiet dinner.
It won’t be a stretch for anyone who knows Chuck to hear that he is a deep yet practical thinker. Our conversation ranged the gamut from sports, to trading, to war stories about trading careers, and to family. A committed family man, Chuck is certainly a role model as a great husband, a proud dad and joyful grandpa. And when the discussion turned toward things spiritual, Chuck’s clear sense of ethics, shrouded in an unmistakable humility and sense of child-like wonder really touched me. It was an evening I’ll not forget.
Next week, I’ll share with you my favorite three trading tips and techniques that I learned from Chuck. I’m sure you’ll find them useful as well. Until next week…
Oh yeah, here’s the link for a look at the LED festooned hat:
And yes, we really did wear them with the lights on…
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Risk Calculation or Profit Factor?
Q:I am working on a trend following system. I am trying to figure out the risk. The system statement is to exit on a loss of -10% of the stock purchase value. Is this my risk for every trade? The system statement is to exit when the moving average slope goes flat.
Each trade value is about 5% of the total trading capital. So this would mean that a ten percent loss would represent 0.5% of the total capital. Is this 0.5% the risk per trade?
With 2,050 simulated trades in a years time. The mean, median and standard deviation for this system is $35, $108, and $550 with 85% of the trades profitable.
It produced a profit of $75K with a total loss of $250K or a profit factor of 1.3. "For every dollar loss 30 cents was made." Is this profit factor another measure of risk or of system success?
A: Thank you for your question. You already have a good grasp on some of Dr.
If your system rule has you exit a position at a 10% loss in the stock, then yes, that is your 1R.
If you are willing to lose .5% of your equity for each trade you put on, then .5% is your position size.
Even though the profit factor is a measure system performance, calculating the system expectancy might be a valuable exercise also.
Your system's expectancy would be the average return of the 2,050 trades in terms of what was risked or R. For example, if you always risked 10% (1R) as mentioned and on average you earned 18% on each position, then your system expectancy would be 1.8R. If you knew what the average risk was in dollar amounts, you could simply divide the average return ($35) by the average risk to find the expectancy.
Based on the numbers you provided, that trend system might have a negative expectancy system but I can't tell for sure. You need to be trading a positive expectancy system (average reward bigger than the average risk) in order to make money.
Good luck and take care.
VP, Research & Development
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