Interview With a Trading Legend - Mercenary Trader

Interview With a Trading Legend
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pain – sharing the love of the game. A sort of trader’s fellowship, which helps remind you how great
the game is and why you play it.
PETER BRANDT: There is a big gap between systematic trading and discretionary trading. If you look
at where the money is being held on the managed futures side, it is not being held by discretionary
traders. It is being held by systematic traders. What do you see as the good points of each, and why
do you think the overwhelming amount of money in futures is managed by systematic traders?
JACK SPARROW: I would say for one, it really goes back to personality and what suits you best in
markets. Jack Schwager, the author of the Market Wizards books, is an example. He talked about
how, after interviewing all those top caliber discretionary traders, he wound up gravitating towards a
mechanical approach because of his natural temperament. He liked the puzzle-solving aspects of
building systems, but didn’t like the up-close interaction with markets. So the systems worked better
for him.
Systematic traders, or what I call mechanical traders, will often talk about the emotional advantage of
distancing themselves from markets with computer-executed rules. Whereas the discretionary trader’s
response might be: “Wow, why would you want to be removed? Why would you give your money to a
robot?”
One of the amusing criticisms of computer-based trading comes from the book Paper Money by Adam
Smith, where his Wall Street mentor says in a Southern accent: “A good dawg is indispensible for
hunting. Can’t do without him. But you don’t give the gun to the dawg!”
Regarding the prevalence of systematic trading in managed futures, a system can be advertised as
reliable in a manner that is harder for a discretionary trader to match. A system is more stable from an
institutional perspective because there is less risk of variation on the human side. A good system is
not like a superstar manager who can suddenly walk out the door. A system can have excellent
longevity, and the marketers selling the system can say reassuringly that “we have zero emotion in our
trades” and so on.
And yet, I think discretionary traders will always have the chops to beat the pants off systematic
traders in terms of long run performance. If you have a performance challenge over many years, I
believe the top discretionary traders will almost always win. But that is because discretionary traders
have more room in both directions. They can soar higher, but they can also screw up royally. They can
crush the computer-based system when things are going well, but they can also underperform when
they get ice cold. So another reason for systematic dominance in managed futures is an emphasis on
steady, reliable returns over higher returns that might be less predictable.
PETER BRANDT: Is it possible to build leakage into a system that is hard to find? That is to say, can a
system have performance problems that are hard to identify and root out?
JACK SPARROW: One of the real drawbacks of a mechanical system is what happens when you go
through a period of drawdown. If you are a discretionary trader in a period of drawdown, the system is
not just your rules, it is literally you. So you have more to analyze: You can look at your emotions and
decision making patterns… you can do self-analysis along with your trades… whereas with a
computer program, the ability to analyze is more removed. “Do I change this rule? Do I change that
one?” Meanwhile the computer says nothing. It strikes me as tougher to respond to challenging
periods when all you have is a sheet of rules.
And of course, we can’t help but interpret these questions through a discretionary trading lens,
because discretionary trading is what we do. I could never be a strict mechanical trader – I enjoy being
involved in markets too much. I love the challenge of controlling and shaping my emotions, adjusting
exposure levels to market conditions, fully engaging with markets as part of the process. So these
one-step-removed guys, hey, that’s great. It is just not the food we cook in our kitchen.
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