Kevin Davey recently won a worldwide trading contest three years in a row. In the fourth year, he placed second. Now that proof that someone knows what he's doing. Kevin writes automated trading systems and is very candid about how it all works. The first thing I wanted to ask him was how do you know when a black box trading system works in the real world, not just paper trading, and how do you know when you need to make a few adjustments or pitch it out and start again? He begins by talking about drawdowns and then gets into how he knows when a system is working properly.
Tim Bourquin: Kevin, tell us your overall trading strategy.
Kevin Davey: The way I typically trade is by developing systems and then rigidly adhering to those systems. Right now, I'm trading about six different systems for my personal account, and four of those are semi-automated where I will get signals but I'll still have to enter them myself. And then the other two systems are completely automated where I don't even have to be at the computer although I usually still am just to make sure everything works right.
What I found is to reduce the drawdowns that occur, I like to diversify and try some different things. So, for example, I'm trading six different systems, so a couple of them are different types of systems with the stock indices, the mini S&P, the mini Russell, mini Nasdaq, so there are a couple systems there. And then I'm also trading some of the agricultural-type commodities and doing some spread trading.
So, really what I found was the best way to reduce drawdown is obviously to have a good system in the first place, but drawdowns are kind of inevitable in any system. And so, by combining a couple of systems, what you get is you can use your capital a little bit better and also it kind of takes some of the sting out of some of those drawdowns.
Tim Bourquin: That's a good point, too, because I was going to ask you how do you know when it's just a temporary drawdown and it's just maybe four or five trades in a row that have gone bad, and historically maybe you don't have that many but it's still within the parameters. And when it's completely off the…
