corporate profile

Aaron Schindler

Mr. Aaron E. Schindler, a Chartered Financial Analyst, is the founder of Schindler Trading. Following is an interview with Mr. Schindler published by the trading psychology website Innerworth.com...

Aaron Schindler is the primary trader for Schindler Trading. A graduate of MIT, Aaron started out as a physicist but left the Ph.D. program at UC Berkeley to take a job with Trout Trading.

His early interest in mathematics and science seems to influence his trading style to this day. He backtests his strategies carefully. He prefers a systematic trading approach to a discretionary one. As with most traders, Aaron didn’t give away any of his specific trading strategies, but we did get him to talk about how he develops them.

Aaron has been interviewed by Technical Analysis of Stocks and Commodities, and Schindler Trading has been covered by Futures magazine.

The Interview

How did you get started in trading?
I was going to graduate school at UC Berkeley, doing research in elementary particle physics, working in a laboratory in Illinois. Then I took a job with Trout Trading. I dropped out of the Ph.D. program and went to work with Monroe Trout in downtown Chicago. That’s where I first learned about futures and how to systematically create and backtest strategies.

What is Trout Trading?
Monroe Trout is currently retired, but at that time he was a commodity trading advisor and commodity pool operator. Monroe Trout was an excellent trader and mentor and there’s a lengthy interview of him in The New Market Wizards by Jack Schwager.

What is a commodity pool?
A commodity pool is a hedge fund that trades futures instead of equities. Commodity pools are also called “managed futures funds”. The name “commodity pool” is a National Futures Association (NFA) term; a legal term. The Commodity Futures Trading Commission and the NFA, as opposed to the SEC, regulate commodity pools.

Where did you go after Trout Trading?
I was working for Trout Trading in downtown Chicago when he moved his headquarters to Bermuda, and my wife and I moved with him. I continued working for him for a couple years, and then in 1995 I joined a reinsurance company that was looking for someone with derivatives experience to help them hedge currency risk and interest rate risk and so on.

Because I had a quantitative background, having gone to school in physics, I also got involved with helping the reinsurance company model and manage catastrophe risk from hurricanes and earthquakes. We started a small homeowner’s insurance company in Florida. About this time, my wife and I wanted to move back to the States, so we moved back to the Chicago area, where I live now. I continued working on the Florida homeowner’s insurance company. I was the chief actuary for the company.

Eventually it became clear that to grow the company I would need to move to Florida to head up an actuarial department. But my wife and I had had enough moving. So I left the homeowner’s company and joined an auto insurance company in another suburb of Chicago.

I worked as the actuary for this startup auto insurance company for a year, but then decided I had had enough with insurance, so I left it and started trading on my own. This was in April of 2000, just after the peak of the NASDAQ bubble. I started trading the e-mini S&P and e-mini NASDAQ.

How much real experience had you had at that point, having been in insurance for so long?
During my years at Trout Trading, I learned a lot about how to systematically backtest, implement, and monitor trading strategies.

How much did you start up with and how did it work out initially?
My wife and I had been saving, and we had a good nest egg to start with. I recommend that before anyone takes the leap to trading full time, they have a few years of expenses covered, or else try to trade around a regular job that can pay the bills. I traded pretty small to start with. Mostly we were living off savings while I was working on strategies. I traded really small to see if the strategies would work and to build up some statistics and find out what kind of slippage I could expect.

Trading went well and the returns were good. I subsequently formed a trading company and began managing money for outside investors.

You’re still the primary trader?
Yes. The company is called Schindler Trading; it’s a sole proprietorship. Right now we trade only futures. I started out with the E-mini S&P and switched to the E-mini NASDAQ, which we still trade. About April of this past year, I added the German stock index futures, and just a few weeks ago added the ten year T-note futures.

Do you mostly use technical analysis for trading?
Yes, price and non-price based indicators with both trend-following and mean-reverting components. I’d rather not go into what exact indicators I use. And I’ll tell you why…

It’s always quite a surprising and joyous moment when I find an indicator that works and lives up to statistical backtesting. Once I start making money with an indicator, one of my biggest fears is that it is going to stop working. One possible way an indicator could stop working is if it gets to be widely known and other people are trading it.

Take trend following as an example. If everyone is doing trend following, your first thought might be, well, it should work even better. Everyone’s going to be buying; it’s going to go up more and more. But futures are a zero sum game, so for everybody that’s making money, someone else is losing money. If the market’s turning up and I’m getting ready to buy, and then everybody knows that people are going to be ready to buy, they’re going to buy a little bit sooner and the market is going to jump up to where it should be on a fundamental basis before I even get in. And my indicator will have ceased to be profitable.

It’s like the January Effect. People started buying at the end of December to catch the seasonal rise. Well, then because everyone was buying at the end of December, the January Effect got moved to an end-of-December effect and became known as the Santa Claus Rally. Now people buy at the beginning of December because it’s historically been a good month lately, so the actual rally gets moved back further and further as people buy in anticipation of other people buying. Now who knows when to buy? End of December? Early December? Before Thanksgiving, perhaps? The January Effect has ceased to be a strong indicator. The stock market is like a beauty contest where the object isn’t to pick the most beautiful contestant, but to pick who the other judges are going to pick as the most beautiful candidate.

Do you trade every day?
We monitor the markets daily, but don’t trade every day.

Do you set dollar goals for yourself on a daily, weekly or monthly basis?
No. I’ve read about daytraders who will try to take $500 out of the market each day, and when they get their $500, they call it quits. If we’ve got a trade on that’s going in our direction and we don’t get a signal to exit, we’ll just let it run. The more the better.

How do you know when to get out?
Well, of course we have our exit signals, but we also use a time limit on a trade. If a trade’s doing really well or really poorly, we tend to get out of it sooner. But if a trade is just kind of meandering along, we’ll give it time to mature and hopefully turn up.

When you learned to be a trader, what were some of the things you found the most helpful?
I hear about people doing discretionary trading, and it boggles me. We’re 100% systematic, and I backtest everything. Much of my day is spent backtesting strategies and indicators, and most of them don’t pan out. But once in a while I hit a gold nugget, and that’s a good day. I think that’s the most important thing: backtesting and understanding statistics so I can make a judgment whether historical performance is a fluke or if there’s some actual, profitable signal there.

You do backtesting, but it’s idealized, because it may have worked in the past but it still may not work in the future.
Right. One way to help protect against that is to have an in-sample data set and an out-of-sample data set. You backtest your strategies always on your in-sample data. You backtest it, you optimize it, and then when you’re all set and you’re ready to trade it, you test your system or signal on your out-of-sample data set. My final go or no-go decision is based on the out-of-sample test. If my test strategy is profitable on the out-of-sample data with realistic slippage and commission applied, then I’ll start trading it on a small level.

What do you mean by out-of-sample versus in-sample data?
Out-of-sample means it is data that was not used in developing and optimizing the strategy. Say you have 9 years of S&P data and you want to develop a strategy. You might take the middle three years to develop your strategy. For example, if you have an idea that the S&P goes up when bonds go down and the US Dollar is strong, then you could test that on your three years of S&P data. Maybe that works and maybe it doesn’t. If it looks like it works, then you can optimize it. Maybe we’ll look at the change in the dollar over the previous year, or maybe we’ll look at a moving average crossover, and then I look for the best parameters. Once I have my strategy all set and I think it’s good, then I test it on the first and last three years and see how it does on this out-of-sample data. The whole idea is to get a realistic picture of how profitable a strategy is without the distortion of curve fitting.

When you implement the trading strategy and it doesn’t work, do you use other variables to see how well they’re doing or not doing, such as how they react in different conditions?
Yes, once you start trading a strategy at a small level, maybe a single contract, it might have a down period. The first thing you’ll be looking at is, what are the chances of having a drawdown? All strategies have drawdowns. If this is just another drawdown in a long history of drawdowns you would’ve had, that’s fine, you just have to live through it. That’s where having knowledge of statistics and trading systematically will help you.

If you do a statistical study that says there shouldn’t be a drawdown of more than $1,000 in any given year, and you’re in a drawdown of $500, no problem. If you’re in a drawdown of $600 or $700, that’s to be expected. But if your drawdown gets to be $1,000 or $1,200, then maybe something has changed about the market. Maybe your strategy isn’t performing anymore. In any case, you can see that the strategy isn’t performing as it did historically. You can find out the same thing on the upside also. Say you expect your strategy to make a 10-20% return in a year. If your strategy makes 50% right out of the gate, count your blessings, but it means your strategy isn’t performing how it did historically and you should be looking for what changed. It’s good to test your strategy with as much data as possible over as many different market conditions as possible before you start trading it.

Could you give us a made-up example of a strategy, since you don’t want to reveal a real one?
Take a moving average crossover strategy, for instance. Take your daily chart of the E-mini S&P closes and do a three-day and twenty-day simple moving average of those closes. If the three-day moving average is above the twenty-day moving average, go long. If it’s below, go short. That’s a real simple strategy. It’s trend following, and it probably makes money too. Trend following in general is a good place to start when looking for profitable strategies.

Would you backtest the strategy on a lot of different commodities to see if it works better for one than another?
Yes. In fact, if you’re doing a simple trend following strategy like that, it’s good to trade as many different commodities as possible. Trade the Yen, trade crude oil, trade gold, trade the Australian Dollar. Trade as many different things as possible to diversify your portfolio and get a better risk-reward profile.

Were you a very methodical person throughout your life?
I think I’m very linear. I can’t do multi-tasking very well. I have to do one thing after another. I think that’s my weakness. My strength is being very methodical and quantitative.

Have you ever had a problem with being a little over-cautious, afraid to pull the trigger?
Sometimes it’s difficult to pull the trigger.

Even now?
It’s getting easier. I had to make it a habit to trade my strategies. When they say to make a trade, I have to make that trade. I’ve learned that if I try to second-guess a strategy as a systematic trader, sometimes I’ll do well, but eventually it’s going to bite me if you keep overriding it. Maybe it’s getting close to my stop loss level and I think to myself, “it’s got to turn around!” So I cancel my stop loss order to stay in the trade. Well, it might turn around and go back up, but it might just keep going down, and I’m going to wish I had gotten out and followed the strategy. I’ve learned to always, always follow the strategy and take the signals when they come. Losses are part of any strategy.

How do you handle your good and bad days?
The emotional side of trading is really a roller coaster, especially for someone who is trading full time. I’ve got a mortgage. I’ve got two kids. We’ve got grocery bills, and when I have a losing day, it can hurt. I wish there was some way to smooth out the euphoria and the nausea: the euphoria of the good days when I’m making a lot of money, and the nausea I feel when I have a particularly bad day.

My wife is very supportive. In fact, sometimes when I have a bad day, I’ll talk to her about it, and she’ll help me focus on the big picture. Humans tend to live very much in the present. Even though Schindler Trading has a very good long-term track record, if I have a losing day, I feel bad. I wish I could figure out how to stay focused on the long-term good results. Losses are just part of life. We’re going to have losing months, eventually we’ll probably have a losing year, but we’ve been profitable so far and we expect to stay profitable. But when you’re in that losing day or losing week or month, it just feels lousy.

And so you haven’t really come up with other ways to come out of that?
My solace is sticking with the strategy. I can look and say, “Okay, we’re in this big drawdown, but I had a bigger drawdown a year ago.” Or, “we’ve had six losing trades in a row, but my statistical studies say that every year we can expect to have a string of nine losers in a row, so having six is not that bad.”
I don’t have to feel so lousy. If the strategy has proven itself over time, it should continue to be profitable. Losses are just part of the game. That’s how I try to comfort myself, by looking at the larger picture and having the rigorous statistical studies to tell me that my strategy is still within expected parameters. Or, if it’s not, it’s time to take some action.

What do you think gives you an edge over other traders?
I think it’s my rigorous quantitative and systematic approach. I don’t think the human brain is wired to be a good discretionary trader. Granted, some people make money at it, but from the studies of behavioral finance, people’s trading decisions tend to be overridden by fear and greed. This is just my guess, but I think there is a gradual flow of money from discretionary traders to systematic traders. I think that’s where my profits are coming from.

How do you measure success?
Both by positive returns and growth in assets under management. My wife and I have a lot of our own net worth invested with Schindler Trading, so of course we want to make money on our investment, and I enjoy making money for our investors. I hate reporting negative results and I enjoy reporting positive results, and I think it’s a successful month when we made money and our investors made money.

Do you view your job as a kind of service job, helping people with their investing?
With managed futures being a risky investment, I don’t want people staking their retirements or their kid’s college fund with us. They should only be investing risk capital they can afford to lose. But when they do put money with Schindler Trading, maybe they’re thinking it will help them buy a vacation home or a boat or something. I can help them grow that money to buy an even nicer vacation home or a bigger boat. I’m helping people afford a more luxurious lifestyle, I think. I think people appreciate that and hopefully they’ll enjoy the fruits of my labors.

Is it important to you to have that kind of function?
I get a lot of gratification when investors thank me and congratulate me for good returns. I really do get a lot of satisfaction from that.

How do you measure success in your personal life?
My personal life isn’t all about money and returns. I’ve got two boys, a three-year-old and a one-year-old, and I think I measure success in how well my wife and I raise our boys. I measure success in having a good family life, and in bringing up my boys to be strong Christians, and in having good relationships in my extended family and community.

What piece of emotional or psychological advice would you give a new trader?
Before you start trading, you should learn how to do some sort of backtesting, so you can have confidence in your system. Whether you use an Excel spreadsheet, Tradestation software, or code up your system in a programming language, you need to have some historical results that you can look at to compare to your current results in order to know whether your strategy is behaving as it should.

Thank you, Aaron.

PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.
FUTURES TRADING IS SPECULATIVE AND INVOLVES A HIGH DEGREE OF RISK.