Algo Trading Secrets Of A Champion Trader (With Kevin Davey) 

In today’s episode, we have Kevin Davey in the house!

Kevin is a World Cup trading champion, full-time trader, and investment manager.

And as you know, in the trading world, it’s hard to find someone who is a world-up trading champion and willing to spill their secrets at the same time.

Kevin is a rare breed.

So here’s a glimpse of what you’ll learn today:

1. Kevin’s growing up years, formative moments, and the transition to full-time trading
2. What is algo trading and how it work (explained in a step-by-step manner that even a newbie can understand)
3. The surprising truth as to why he has 200 trading systems (and only picks 35 at once to trade)
4. How to tell when a trading system is no longer working and what you should do about it
5. The reason why he avoids trading stocks and it’s not what you think
6. Is algo trading suitable for you? Here’s how to tell…
7. How to get started with algo trading even if you have no experience
8. And much more…

So sit back, relax, and enjoy my conversation with Kevin Davey…

Rayner (06:21)

Awesome, okay, let’s get to it…

Kevin, welcome to the show. For those of you who are watching, this is the first guest we have on the podcast.

So welcome, Kevin!!!

Happy to have you.

Kevin Davey (06:36)

Wow, I’m impressed I’m the first guest, but thanks for having me on. I appreciate it.

Rayner (06:43)

One thing to share Kevin is that I appreciate you. I know that you’re a World Cup trading champion in the futures market and it’s not easy.

What’s remarkable that made me want to salute you is that you also write multiple trading books on trading to help retail traders.

Trust me, I’ve written books myself.

One book is almost one thing in your life. And I believe you have written multiple such books helping retail traders out there in the world plus having your credentials of winning the World Cup of Trading.

Thank you for your effort in trying to educate us.

I appreciate you, Kevin.

Kevin Davey (07:18)

I appreciate the kind words. Thanks.

Rayner (07:22)

Great, so let’s kick things off.

I just want to hear a little bit about your life. I think most of the time, people will ask…

How do you get started in trading?

Why do you become a trader?

But let’s take things maybe a little bit behind like your early years.

If I were to ask you to give me one word to describe your childhood, maybe that would be between 5-12 years old.

What would that one word be?

Kevin Davey (07:47)

Wow, that’s a good question.

I would probably say “playful”

The reason I would say that is because back when I was that age, kids played outside all the time.

We didn’t have phones and computers; we didn’t even have video games yet.

They were just starting to come out and so.

I’d end up spending a lot of my time playing outside.

I wasn’t very good at things like baseball or football, but I enjoyed it.

I was spending a lot of time outside, which a lot of kids now just don’t get that. They’re so tied to their technology.

I think that’s a little bit sad.

Rayner (08:41)

I can resonate with it.

Always looking at their phone. When I see people on the street, they look at their phones instead of embracing the present.

I think it’s a waste.

Just like you, I have kids and I try as much as possible to educate them.

At times, restrain the amount of screen time that they are watching.

Kevin Davey (08:59)

Yeah, that’s tough to do though, isn’t it?

It’s tough to hold them back.

Rayner (09:08)

Your teenage years are between 13 to 21 years old.

If I were to ask you one word to describe your teenage years, what would that one word be?

Kevin Davey (09:15)

I would say driven and what I mean by that is just High school and then College, University.

I was driven to do well in school and try to get good grades and a degree out of the University.

All my focus was to do well with my studies.

Hoping it will prepare me further down the road.

What was interesting is in University, I went into engineering.

Specifically, it was “Aerospace Engineering”

It was like designing aircraft. I was in that field for probably 20 years, that goes a little bit later, but I ended up somewhere completely different, which was in trading.

But…

Some of the lessons I learned, persistence, and dealing with frustration when I was studying in my teens kind of helped out in my later life.

Rayner (10:26)

I’m hearing the word “driven”.

I’m just thinking, is there anything that happened that made you driven?

At least from the people around me, when we were teenagers.

Almost none of us are driven.

We just want to play, and have fun.

The word driven is something rare if you ask me.

Was there anything that happened that made you feel like…

“Let me ace my studies and let’s do this”

Kevin Davey (10:54)

Yeah…

A lot of it was probably just my family.

Mom and Dad were always pushing me hard. My dad was great. Dad was a firefighter and he also owned a pest control company he had two full-time jobs. So, he never pushed me.

But what he did was he set an example by just the way he lived his life.

During those teenage years, he endured three open heart surgeries. He first had one when I was seven years and the other one was when I was in High school.

He had another open-heart surgery in his thirties and he never complained.

He just kept pushing on.

I was driven just from watching him and seeing what he was doing and that kind of led to me being driven.

Rayner (12:14)

Wow…

I think that sends a very powerful message.

As a parent myself, sometimes I wonder how can I best educate my kids.

But as you mentioned, sometimes actions are the thing that matters.

You can say all you want, but if your action doesn’t tell. The kids will probably follow your actions. I think leading by example is such a classic.

It works…

Kevin Davey (12:37)

Yes.

Rayner (12:44)

Earlier you mentioned Aerospace Engineering.

I guess that’s your first job?

Kevin Davey (12:45)

Yes.

That would be my first real job out of university.

My first professional job.

Obviously, before that, when I was in high school, I worked at a local ice cream store.

I stocked canned goods at a convenience store.

I worked as a busboy.

I worked for an Aerospace company in California. That was my first career-type job.

Rayner (13:37)

What were you doing back then as an Aerospace Engineer?

Kevin Davey (13:42)

I can’t talk about some of it because I had a secret clearance but you know it was defense-related projects of designing the next generation of air of military aircraft.

I also worked on a project that was kind of interesting. This was when people in commercial airliners were shot at with missiles, like surface-to-air missiles.

I was on a project where we developed an object that would be launched out of a commercial aircraft, and it would intercept a missile to protect the aircraft.

It was things like that…

That was my first job.

After a couple of years, I went more into the space part of it.

I was working for a small company in California that made…

This is going to sound weird, inflatable balloons for outer space.

It was basically like a Mylar balloon.

What you do is you fold it up and it becomes really small. You put some kind of material like crushed-up moth balls in it.

Rayner (14:55)

Wow…

Kevin Davey (15:12)

Then when you send it to outer space, because it’s a vacuum out there, what’ll happen is that little container will expand and be huge.

What it would do is they could make shapes and it could resemble a missile warhead in outer space.

So other defense people would then see it and they would design their tracking system and their laser system or whatever to track that incoming nuclear warhead.

We also did some experiments that flew on the space shuttle.

I was involved with a project that designed a huge antenna that was inflatable and it was deployed in space.

There were a lot of projects I worked with.

Rayner (16:15)

You earlier mentioned the commercial airline where you have something sticking out to prevent missile effect.

I haven’t seen that yet.

Is it in existence now?

Kevin Davey (16:26)

No, it was a great idea. It just never got implemented.

The company I was working for. The firm being a large defense firm, what happened was there was a lot of infighting between them.

A group in California and a group in Georgia that made the components. Each group thought they should be in charge of it.

Doing that, turned the Government off and they said…

“You guys are not serious”

The Government would have funded it ultimately so I ended up getting cancelled.

Never got built. We ran some tests.

That was about it.

This happens a lot in the defense world, they would get a design and people would go crazy. This is going to be a great idea. Then it would die and never get built.

That unfortunately was part of the business.

Rayner (17:36)

What are some of the biggest reasons why projects just fail?

Is it because of either funding issues, or there are other more pressing matters to pursue?

Kevin Davey (17:49)

Yeah…

What I was involved with was pure research and development.

We were always fighting with other projects, not only within our company but within the whole defense industry as a whole.

The government would pick and choose which ones to fund, and which ones not to.

It started getting into a lot of politics.

It may not be the best idea that goes forward but maybe a politician has a district where a company has an idea.

He’s going to push for it to get funded and things like that.

It was a survival of the fittest.

But a lot of times, from what I saw, the best ideas didn’t always push to the front. They died a lot of times.

It’s probably the same for pharmaceutical companies etc.

Rayner (19:16)

I hear the word best a few times. How do you define what’s the best feature?

Kevin Davey (19:23)

That’s a tough one.

It’s very subjective. You know you might think well…

“Hey protecting commercial airplanes”

That’s the best idea, but somebody else might be coming up with some new guidance systems for an aircraft.

That’s a better idea and you know sometimes, it comes down to money.

I don’t know why a lot of times; different things get picked.

At the time, I was just a mid-level Engineer. I wasn’t one of the top decision makers and those are the people who got to make the choices.

Rayner (20:07)

I’m curious, so you studied Aerospace Engineering and you helped develop such ideas.

When you are working in such a firm, how often do you deal with math each day?

From my knowledge, you will be looking at the calculations and equations on a day-to-day basis.

Is there more to it than just numbers and equations in the real world?

Kevin Davey (20:38)

A lot of it was numbers and calculations, computer programs, and simulations.

You had to do a lot of that.

But the other thing I found with a lot of engineering work was promotion and sort of self-marketing.

An example, it wasn’t necessarily that you came up with a good idea, but it was…

“How you could stand up in front of people and present that idea and get them over to your side and make them understand what was going on.”

I remember the first time I ever had to do it.

I believe it was a three or four-star general who had come to visit our plant.

There were lots of pretty high-level people at our plant and somehow, I was chosen to talk on a certain topic.

You can believe I was scared to death.

That taught me the importance of putting yourself out there and trying to get your ideas across.

Those guys didn’t care about the math.

They assumed the math and all the programming and everything was right.

They wanted just to hear the ideas and envision it kind of thing.

A similar thing was, that part of that program to develop the commercial airline for the missiles was I worked with somebody in another department to create a computer-based simulation.

It was a graphic one, which nowadays you could do it. It would look like any kind of video game.

But back then, that was a big deal.

I helped create the simulation where I could run cases of…

“Hey, the plane’s flying like this, and then somebody shoots a missile at it, and then you see the missile coming at you”

If you look at different camera views, simulated camera views.

I’d be running those, and people would see it in this computer area, and higher-ops would see it, and that’s what got them fascinated.

Again, there was math behind all the ideas, but what brought it out was the presentation of it and the promotion of it.

Talking about our kids earlier, that’s one of the things I’m big on teaching my kids.

I have a daughter who wants to be a writer. I said…

“Well, realize being a writer, hey, that’s great”

But in the end, if you want to write books probably 80% of your time is going to be promoting the book, not writing the book.

That’s what it ends up becoming.

Promoting yourself and putting yourself out there and that’s true in a lot of things in life.

Rayner (23:50)

Yep. How to sell yourself in essence.

Kevin Davey (23:52)

Yeah, absolutely. Which I never, did as an Engineer.

I took one class that I remember in the University for presentations.

You did one stand-up presentation and that was it in four years.

I look back on it now and I’m like…

“Wow, they just did not prepare me enough for doing that sort of thing”

There should have been a lot more.

As I’ve gotten older, I’ve realized that promoting yourself, and what you do, no matter what your career is, it’s a huge part of being successful.

Rayner (24:51)

Well said…

I couldn’t agree more.

Not just in trading or business, but even as an employee.

If you want to sell your ideas to your uppers to get certain things moving, you have to sell.

Sell the other ideas and yourself. That also helps with promotion within the company, if you can sell yourself better than your peers.

Even as much as we hate to admit it, sometimes your work quality may not be as good as your peers, if you can sell yourself better, you have a higher chance of that promotion.

Kevin Davey (25:19)

A lot of people tend to think that it’s not genuine when you do that.

They feel bad about promoting themselves, but ultimately, like we were just talking about, the best ideas don’t always become reality.

It’s the ones that are promoted the best that are good ideas. That’s what people have to realize.

Rayner (25:47)

Great.

You said you had 20 years in Aerospace Engineering before you got a second career in trading.

So how did that transition happen?

Kevin Davey (25:57)

Well, it took a long time and it started when I was working as an Engineer.

I was in California and I received something in the mail.

This wasn’t an email; this was like paper mail and it was like a 15–20-page booklet that talked about trading.

It read…

“If you had bought sugar here and sold it here”

You would have been a millionaire.

I saw that and I was like…

“Wow, this is neat”

I didn’t even know what futures or commodities were but that started it.

I started digging into it and trying stuff and losing money and then trying other stuff and losing money.

It was hard to get good information or any information.

There were a few books and that kind of thing, but there was no internet.

You know, there was no trading software where you could just pull up a chart and throw a moving average on it.

Back then you’d get, if you wanted future data, it was either the daily newspaper.

It would give you the prices for the previous day.

There were some subscription services that once a week would physically mail you a copy of the charts.

You can add to them and draw your lines on them.

That kind of thing and that’s what it was back then and so that started my obsession I guess with the markets.

From that point on I just kept trying stuff.

I would try in the real world and lose money so I’d be like…

“Oh, you can’t do that and I move on to something else”

For the longest time, I thought…

“I was going to create the ultimate money machine where it would be some kind of indicator or pattern or whatever that would just make a ton of money and I could just sit back and just wait for the money to flow in”

Of course, everybody thinks that and it just doesn’t happen.

Eventually, I started getting a little bit better at it.

Had some huge setbacks along the way, but I was doing all that part-time so it was my part-time hobby.

It was the only thing I did outside of work and this was before kids and they took up time.

Eventually, I got to the point where I was pretty decent part-time trading.

That led me to enter the World Cup Trading Contest and I was able to finish second a couple of years.

In the first year, after that, I started to feel like…

“Maybe I can do this full time and the way it worked with my job”

I was in charge of quality assurance and engineering in a company that had about 500 hundred persons who made fuel pumps for aircraft.

Which was a pretty high-stress job.

Looking at it, if the fuel pump fails on a jet engine, the jet engine stops and that’s not a good thing.

We had super strict tolerance.

We were always worried about bad products.

Eventually, our company got sold to a big company and I had the opportunity to walk out of there with basically an extra year’s salary. Because I stayed on through the transition.

That just turned out to be the perfect time. I said…

“I’ve always loved trading. It’s been my hobby. I think I’m decent enough at it, maybe I should just do this full-time”

Give me a year and if it doesn’t work out, I’ll go back, and get another job in aerospace.

But if it does work out, I’ll stay in trading.

That was like in 2008, about 15 years ago.

Turned out it worked out and here I am today, still trading full time.

Rayner (30:41)

Correct me if I’m wrong.

From what I’m hearing, you took part in the World Cup of Trading, you came in the first place while doing it part-time.

Did I hear that right?

Kevin Davey (30:51)

Yes.

That was 2005, 2006 and 2007. I was working full time and it wasn’t just an engineering job.

It was an upper-level management at this company. I was probably one of the top three at this company.

It was good and bad.

It was good because what I did was, I created trading systems that would only trade maybe at the market open and they didn’t do much during the day.

I wasn’t doing active trading during the day because I couldn’t, I had a full-time job.

So, I could check during lunch and maybe one or two other times in between meetings or something, I could sneak a look at the markets.

I didn’t trade that much during the day. That helped me because I didn’t try to overdo things.

Most people who start trading tend to overdo it and trade too much having much risk.

I think having a full-time job helped me in that regard.

Rayner (32:12)

You should put it somewhere in your bio.

“World Cup trading champion doing it part-time”

Laughs

You can share with us and the audience, what is your trading methodology today.

I know it’s algo trading, but I think most of them might not be familiar with it.

So maybe you can expand on that.

Kevin Davey (32:17)

Hahaha…

So algo trading. What it means is you trade according to established rules.

These rules could be anything. It could be when the price crosses a moving average that’s a buy signal.

It could be when you see a doji candlestick and something else, that’s a sell-short signal. It could be anything.

The point is, with an algo, you write down those rules and you program them into a trading platform.

 I use Trade Station, but there are a lot of other pieces of software out there that’ll do it.

You program the rules.

Let’s just take an example of a moving average crossover.

If the close yesterday was below the moving average and the close today is above the moving average then buy the next bar at the market.

That would be an algo rule.

You could have the exact opposite for a sell short, you could put a stop loss in there, all kinds of variations.

You come up with that idea, and then you program it and run what’s called a backtest on it.

You go back 10-20 years.

You let the trading platform apply those rules to a chart of crude oil or a chart of Amazon or whatever you want to test, and it will quickly do it.

You’ll come out and say…

 “If I had done that and followed those rules, I would have made this much money”

That’s what algo trading is and it’s different with how a lot of people trade.

A lot of people use charts and they’ll stare at charts all day and they’ll draw their support and resistance lines and trend lines.

They’ll say watching it in real-time…

“If the price breaks a trend line, I’m going to go short”

They’ll look at order flow and say…

 “Oh, there seems to be a buying imbalance. I’ll buy or sell”

Those people trade a lot differently.

They’re more focused on what’s happening right now and try to react to it.

But they don’t necessarily do the historical testing to prove that what they’re doing ever worked.

The big thing is that algo trading allows you to back-test it and show that something has worked.

The big drawback to algo trading is just because something worked for the last 10-15 years doesn’t mean it’s going to keep working for the next month to a year.

It could be nonsense or random luck, where it just happened to work the last 10 years.

But going forward it won’t work at all.

That’s where people get tripped up.

They think…

“Well, I had a great backtest, therefore it should work going forward”

That’s not the case at all.

You know that the disclaimer the US government always has…

“That the past performance is not necessarily indicative of future results”

That’s 100% true.

But what I’ve found is when you backtest a certain way you backtest correctly and do things like you don’t over-optimize.

Which is to put too many rules in your strategy and try to overcomplicate it.

When you don’t do things like that, there’s a tendency for the backtest to continue and do good.

It’s not a guarantee.

But the way I always describe it is…

“You’re shifting the odds in your favor a little bit”

A lot of times that’s all you need.

If you think about gambling and casinos.

They have a small edge when you’re playing roulette.

They don’t have a huge advantage, but they have a small one and it’s always there and it works all through time and there’s no way around it.

All they need are people to play it and eventually, they’ll be winners in the long run.

What I found in trading is a lot of times you don’t need a huge advantage to do fairly well.

You just need some advantage that’s in a nutshell what algo trading is and how it works.

Rayner (38:14)

Speaking of backtest…

This reminds me of a quote by Jim Simmons.

The one who runs one of the most successful hedge funds in the world.

He said that…

“Past performance is the best predictor of success”

 I think I came across one of his quotes, and I agree with that.

With what you have said, if done correctly, that’s one of the best ways to have it work or not.

But the context is that it has to be done in the right way.

Kevin Davey (32:17)

One way to think about it is, if you run a backtest and it shows it lost money every year for the last 10 years, would you even consider trading it?

Probably not, because you’d be like…

“Well, this has never made money, why all of a sudden would it make money?”

There’s that part of it.

The flip side to it is just because it did make money in the past 10 years doesn’t guarantee it will make money going forward.

But if I had my choice between the two or three choices.

Choice one backtest is negative all through the history. Choice two backtests are positive through the history choice. Choice three you have no idea you didn’t do any testing.

From a logical point of view, which one are you going to take?

You’re going to take the one that was profitable in the past.

You’re going eliminate the one that didn’t make money and the one that you didn’t test.

How much confidence would you have trading that?

I see that a lot where people just say…

“Well, I think this will work”

 Then they just go and do it without doing any testing.

Which is crazy…

But I guess it explains why a lot of people lose money in trading.

Rayner (40:07)

Also, I believe that one of the reasons so many people don’t do backtesting is that they need programming knowledge tools, and resources to do it, which adds to the obstacles to overcome.

Maybe later on we can talk about some of the tools and resources to help overcome those obstacles.

But for now, I’d like to hear your thoughts.

As you’ve mentioned, there are different ways to trade the markets, algo trading, discretionary trading, order flow, etc.

What made you decide to go down with this approach?

Kevin Davey (40:37)

Probably because I failed so miserably at discretionary trading, which requires you to look at the screen and try to decide in real-time.

I seem to be good at making the wrong decisions.

I’d be watching the chart as the day goes on and I’d be like…

“Oh, now’s a good time to buy”

 As soon as I buy the price falls and eventually, I try to get smart maybe whatever I’m thinking, I should do the opposite.

I tried that…

But it didn’t work.

It was discretionary trading and was just trying to trade to some principles rather than rules like…

“Oh, when an uptrend, you always want to look for buying opportunities”

That kind of thing.

It just didn’t work for me.

What I found was writing down rules and testing them.

Seemed to fit my personality more.

I find that’s true for a lot of people who are technically numbers-based.

I’m referring to engineers and medical doctors.

What I don’t get are people who are like social workers or philosophers. I do get a few musicians sometimes they don’t tend to do algo trading.

But logic people fit for algo trading.

That’s what I am, that’s algo trading.

Rayner (42:51)

Nice…

Perhaps, you can give us an example of a trading system so the audience can understand this better.

Of course, it doesn’t have to be a trading system that you currently trade.

Don’t want to take your secrets, but maybe just a sample trading system so they can understand like…

“Oh, this is what Kevin is talking about and how it works”

Kevin Davey (43:09)

A simple breakout system is a great example that a lot of people will say…

“Oh, breakouts don’t work”

“But to catch long-term trends, which is a good way to make money, breakouts work great”

What you’d say, the rule would be…

“Hey, if today’s close, let’s say you’re working with daily bars, today’s close is the highest close of the last 20 bars”

Which is roughly a month.

If today’s close is the highest close in the last month, I want to buy the next bar at the market.

Conversely, if you’re trading futures, it’s easy to go short.

You could say…

“If the close is the lowest close of the last 20 bars, sell short the next bar at the market”

That’s your entry rule.

You could put a stop loss. You say…

“If I lose $1,000, I’m just going to exit”

You could do a profit target.

There are all sorts of things you could do.

With that kind of system, you’re guaranteed to catch all the long-term trends because a long-term uptrend is going to have higher closes.

After all, that defines a trend.

In that respect, if the trends are long enough, you’ll make quite a bit of money.

It’s just those periods where the market goes back and forth, where you’ll get a lot of false signals, and that will usually lead to periods of drawdown, which every trading system has drawdown.

I see a lot of people out there claiming…

“Oh, hey, this approach has no drawdown, and a drawdown is just a loss from your peak equity”

Every trading system has drawdowns.

As long as you can withstand the drawdowns you will enjoy those profits.

But if you can’t handle the drawdowns, if they’re too severe or just too long in duration, then you might decide…

“Hey, the profit that I’ll get from this strategy isn’t worth those drawdowns”

Because the drawdowns ultimately, the down periods, that’s what kills people a lot of times in trading.

A lot of people love to see new equity highs every day. I certainly do.

But

“Hey, there are times when you can go for months and be in a drawdown”

I recall years of my trading where the first 10 months of the year, I was either flat or losing money.

Then all of a sudden, in the last couple months of the year, things just turned around and skyrocketed and it made like a year’s worth of profit in two months.

But, I had to endure 10 months of drawdown.

That’s hard for most people.

It’s those drawdowns that suck the confidence out of you and they make you doubt everything.

But…

If you can withstand them, you can get somewhere and so that breakout system, I just mentioned is a good example of one that could make money but would also have some could have some significant drawdowns.

Rayner (47:22)

Maybe I’d just like you to do a bit of clarification.

In algo trading, some people use the terms systems trading, systematic trading, and quantitative trading.

Would you say that they all refer to the same thing?

Is it just a different way of calling it?

Kevin Davey (47:39)

Yeah,

I mean there are a lot of different variations on it.

Some people will consider algo trading using statistical rules.

They research past prices and they find out,

“Hey, Monday is a good day to buy and Wednesday is a good day to sell in a particular market”

But again, no matter how they got the idea, it always goes down to rules.

It’s rules you can program, and pure algo trading is just rules.

It doesn’t have any discretion where you say…

“Well, normally I’d take this trade, but the Fed has an announcement today, so I’m not going to take it”

That leads to a lot of issues.

Pure algo trading is just creating those rules and then just follow them and you can automate them that’s the nice thing and you just let them run and it is not easy.

Rayner (49:39)

From my understanding, your algo trading is for specific markets, like the futures markets, commodities, etc.

Kevin Davey (49:48)

Yes…

I mainly do futures markets and there are a few different reasons for that.

One with futures, you can get great leverage as far as, you can control a lot of coffee, crude oil, mini–S&P futures.

You can control a lot with a little bit of money.

You can get some outsized returns.

The downside to that is that “leverage”

When it goes against you can get hurt so you have to be careful with that, I also like it for the diversification.

In the US futures markets, you have six to seven unique sectors. Like the egg, wheat, corn, and soya beans, and you have metals.

A lot of times don’t act the same, they are under different fundamentals

You can create a gold algo.

You could also create a different soybean algo and they could balance each other out.

When one’s up, the other one might be down, but you combine them and you get a nice equity curve.

That is it.

For people in the United States, futures trading has a huge tax advantage with the way they treat short-term gains and long-term gains.

For example, if you were to buy a stock in the US, if you hold it, I believe it’s less than a year, it’s considered a short-term gain and it’s taxed at a higher rate than if you held it more than a year.

They’re trying to encourage people to hold it for longer periods.

But with futures, I could hold a futures contract for literally one second.

Let’s say I make money in that one second and I exit.

For tax purposes, that’s not considered a short-term gain. There’s a good percentage of it.

I think it’s a 60-40 split between long and short-term.

Where a lot of it’s considered a long-term gain taxed at a lower rate.

That’s a huge advantage to trading futures.

Also, a related thing is bookkeeping, it is so much easier.

Anyone who’s ever done stock trading in the USA knows at the end of the year, you have to list all your buys and sells.

You might have lots of pages for that if you are active.

But with futures, it’s one number you get from your broker.

You have to transfer one number to your tax form. It’s your mark to market gain or loss for the year in that account.

It makes record-keeping so much quicker and easier.

All those reasons you add them up and that’s why I trade futures

Rayner (53:08)

I hear you saying algo for soybean and gold.  

I’m guessing you trade multiple trading systems.

How many systems do you currently trade?

Kevin Davey (53:19)

I actively trade about 30 to 35 strategies in various markets.

I have a stable of about 200 strategies.

Every month I do some review and look at which ones I should be trading.

That’s based on not only their performance, it’s also based on things like their volatility and the market sector.

For example just because last month I had all my crude oil strategies do great doesn’t mean I’m going to just trade crude oil strategies the next month.

I want to be diversified because you never know when a trading strategy is going to either permanently or temporarily stop

I’ve had cases where I’ve had strategies that for a couple of years they’ll just go flat and they’ll just kind of be up and down not doing much.

Then all of a sudden, they take off again and start performing well.

You can’t predict what’s going to work in the future.

What I do is I try to have a balanced portfolio of some eggs and metals, energies, and currencies and try to be in a bunch of different markets at the same time.

Rayner (54:53)

I think a question that is going to be in the audience’s head is that…

“Man, Davy, how do you manage 35-200 trading systems?”

What’s your take on that?

Kevin Davey (55:04)

Well…

It doesn’t happen overnight.

I remember this was probably 20 years ago.

I remember building systems and at the end of the year, I’d say…

“What am I going to trade next year?”

I have four strategies that I could use. So, I need more.

So, you have to constantly do the research and development to build new strategies then over time I’ve gotten a little bit better at it.

The tools have gotten a ton better.

Now I can use some tools.

One tool I use, a student of mine wrote, he took some of my principles and made it so he automated a lot of things in development.

It makes developing strategies a lot faster, but you have to just keep developing.

You also have to have some kind of organization for how you’re going to track 50-100 strategies, and how you’re going to select which ones you’re going to trade.

There’s a lot more to it than just developing the strategies themselves, but that’s where it starts.

I mean, if you can’t develop strategies that make money in real-time, it doesn’t matter if you have 100- 200 of them if you can’t do that you’re not going to get anywhere.

That same thing holds for position sizing because some people say…

“Oh well It’s all about money management and position sizing”

That’s very important, but if you don’t have good strategies to start with, money management isn’t going to save you.

It isn’t going to turn an unprofitable system into a profitable one.

There’s a lot to it, but the way to do it is just to start doing it small.

In the next six months, if you can develop one or two strategies, I’ll be okay.

If you do that every six months, well a couple of years from now you might have five systems and strategies you could trade and you are well on your way to building more.

Rayner (57:37)

Let’s say…

You have like 200 trading systems at your disposal.

And you are trading about 30-35 right now.

Also, you said, you try to expose yourself to the different market sectors like the currencies, commodities, etc.

Because you just do not know which market will shine.

My question would be…

How do you determine this system will be trading commodities?

Let’s go with the system ABCD to trade commodities, and system XYZ to trade currencies.

How do you pick the systems to trade that specific sector?

Kevin Davey (58:08)

Well.

The way I usually develop strategies is already market-specific.

Let’s go back to that breakout system example.

I will test that on different markets and find out…

“Oh, it only works well with crude oil”

That’s now a crude oil strategy that will be part of my 200 strategies. Then I’ll never use it on any other market…

It has to work first on whatever target market and also target bar size. I’ve had strategies, I have plenty of strategies that work great with 30-minute bars.

But you give them daily bars and the system falls apart.

There are a lot of people out there that would say…

“Well, it’s got to work”

My strategies have to work on every market or every bar size or it’s got to work in at least 10 markets.

If that’s your criteria, more power to you.

But my experience is that is tough to do.

It’s hard enough to find strategies that work in one market.

Now you’re saying…

“It’s got to work in 10 different markets”

The reality is those are very few and far between.

I’ve found more success being very market-specific.

When I start looking at those 200 strategies to trade every month, I already know the market the bar size, and the strategy itself.

The combination of those three is what I’m tracking.

What I will do is have some rules that would determine which of those 200 should I trade the next month.

It’s really hard to do. Because you might choose the ones that would do bad.

There’s a lot of hindsight.

Rayner (01:00:40)

You also develop rules to pick the trading system to trade in live markets.

Did I hear you right?

Because there’s so many to choose from.

Kevin Davey (01:00:45)

Yeah, yeah…

That ends up becoming almost as important or even as important as the strategies themselves.

The good thing for people starting, they don’t have to worry about that yet.

They just have to focus on building the strategies and you’re trading a few different strategies. That’s a great start,

But eventually if…

If you build a whole bunch, you’re going to have that problem of which ones should I trade.

Rayner (01:01:22)

How do you know when a trading system is no longer working?

Kevin Davey (01:01:30)

That’s a great question…

It’s funny that you asked that because it’s a question that comes up quite a bit now.

But I’ll take you back.

I want to say about 10-11 years ago.

I wrote an article for a magazine.

It was called SFO magazine.

It was related to a brokerage in the US that eventually went out of business because the founder of the brokerage was forging the financial numbers and basically stealing all the customer funds and now, he’s in jail.

But I wrote an article for them on when to quit trading a strategy, an algo strategy.

Back then, this just tells you how the times have changed. I don’t even think we were calling them algo strategies then.

They were calling them systematic or mechanical systems.

But I wrote an article about that.

At first, the editors were like…

“No, we don’t want it. I said, why not?”

This is a good topic. And they said…

“Well, we want happy articles, showing great strategies of people making money.”

We don’t want to talk about what happens when a strategy goes bad and you lose money.

That’s awful. I’m like…

“Yeah, but it’s really important”

I finally convinced them to print it.

The response I got was pretty amazing. I mean, people were like, wow…

“No one’s ever talked about this”

Here we are 11 years later it’s a pretty common question.

How do you know when a strategy is broken?

There’s a lot of different ways to look at it.

You could look at the back-tested drawdown.

You could say…

“If going live, I ever have a drawdown like that, I’m going to exit”

That could be your quitting point.

You could do things like…

“Hey, I’ve looked at the past 300 trades for this system, and it’s never had more than four losing months in a row”

That was its biggest drawdown.

Now all of a sudden you go live and a little bit into it, you get five months in a row losing.

Well, maybe that’s time to put it on pause because maybe it’s not working.

There are a lot of different ways to do it.

One way I always used to use, I don’t use it anymore, but I would print on paper an equity curve of the backtest.

Then I would also include the live trading or the real-time trading of that system on that equity curve.

I’d put it on a wall on the other side of my office. And if I could look at that chart without knowing anything else, if I could tell when that system went live because the performance fell off, then I’d know that the system’s probably broken.

But if I couldn’t tell if it looked about the same as the equity curve, I’m like…

“The back-tested equity curve looks pretty good”

A simple eyeball test is good.

The biggest rule I have found is

“Whatever approach you come up with saying at this point I will consider this approach broken and I will turn it off”

Write it down before you start trading live and put it somewhere where you will review it or if you have a trading partner, they will call you on it and say…

“Hey, you said if this ever happened, you’d quit trading this system”

Has this happened?

Because if they hold you accountable. It’s hard for you to say…

“Oh no, it’s never happened”

The point is if you have rules beforehand and you stick to them you become as emotionless as you going to be upset that you are going to have to quit a system because it’s losing your money.

It’s really hard.

What most people do is they start a trading system and they start thinking about the Lamborghini that they are going to buy.

They think about all the toys they’re going to buy with all their trading winnings and things start going bad.

You know they go into denial.

 “Oh, it’s going to turn around, I’ll let it do one more then I’ll turn it off”

They let it just wipe out their account.

Or they are so strict and go like…

“I lost it yesterday, my system’s no good”

I’ve talked to people who run a backtest and they say…

“I’m going live with it”

A week later, I check in with them and they’ll say…

“Well, it had two losing days, so I don’t think it works.”

I’m like…

“Well, your backtest had multiple losing days?”

Yeah…

“But this wasn’t what I was expecting, so I’m just turning it off”

People sometimes turn them off too soon.

One of the best ways I would say is just looking at the drawdown.

If you get to a drawdown that you never saw in the backtest, it’s probably a good time to pause at least and just make sure that you want to move forward with that strategy.

It could always recover.

Then when it does, maybe that’s time to turn it back on, but you want to stop it from just bankrupting your account.

Rayner (01:08:02)

I heard a saying…

“Your deepest drawdown is always in the future, not in the past”

I mean, it’s going to be a matter of time before whatever trading system, the drawdown will exceed the previous drawdown.

Do you have a buffer, like maybe 1.5 times the maximum drawdown or 1.2 times before you say…

Time to reassess, time to pause, or stop altogether?

Kevin Davey (01:08:23)

Yes…

I used one.

I like 1.5.

The problem I’ve seen with some strategies is when you look at the dollar amount, just assuming you’re trading even one contract, sometimes the dollar amount becomes the bigger issue and then you think…

“Well, wait, it’s one and a half times the drawdown, but I don’t want to lose that much”

 On The flip side, so you can go bigger, you can also go smaller.

You could use one-half of the max drawdown; say at that point I’m turning it off.

That just about guarantees you will turn off a system because it’s half of what it was in the backtest.

You know reality is not going to be as good as the backtest.

There’s a well-known author, Trader Brent Penfold.

He’s written a couple of great books he mentioned that was his approach. This was a few years ago.

Maybe he doesn’t do it anymore, but that was his approach.

And I said, well, you’re almost guaranteeing you’re turning off your systems at some point.

Is that what you want to do? And his response was…

“Yes, because I have more fear of losing a lot of money from a broken system than what would happen if I didn’t quit early enough”

I’d rather quit too early than quit too late.

There are a lot of different variations you can do on it, but my advice to everybody is to come up with a way that you feel comfortable with and then stick to it.

That’s the tough part.

Rayner (01:10:14)

If I recall you mentioned that you might pause the system and then as it recovers the drawdown you might enable it again.

I’m guessing you’re looking at things like maybe if it recovers half the drawdown, you might consider turning it on again.

Is that what you mean?

Kevin Davey (01:10:27)

Yeah…

I’ll still monitor strategies that have underperformed for a while.

I’ll keep watching those to see if they come back. It just helps.

The more real-time data you have helps when you’re developing systems of figuring out things you might have done wrong in development and improving your whole development process.

It’s good to track systems for a long time.

Sometimes, they fall off and then they come back.

But what I have found with those, psychologically, those are hard to come back to and start trading again.

The example I always use is to imagine your spouse or your significant other cheating on you.

You’re going to be devastated.

They say a little while, time goes by and they say…

“Oh, I’m different now, I want to come back and get together”

How likely are you to give them that second chance?

You’re going to be kind of hesitant…

It’s going to be kind of scary.

That’s the same way with a trading system that costs you money and it failed you.

Now it wants a comeback with your money and say…

“Now I’ll make you money, I promise”

You’re going to be a little hesitant.

The reality with coming back to any system that has lost you money is very difficult.

Rayner (01:12:24)

I know you trade a specific trading system for a specific market, but at the same time, other traders trade like a basket of markets.

Example.

Stock traders, trade, all the stocks in the S&P 500 or maybe a trend follower who trades all the different futures markets, trading breakouts and riding trends.

What’s your take on trading a specific instrument, like let’s say gold versus someone who trades a basket of such instruments as stocks or a trend follower who trades a basket of futures markets?

Kevin Davey (01:13:02)

I do think trading a basket is better because if Gold will be in an uptrend, but maybe crude oil is flat and not doing anything.

The more markets you’re in, the more chance you have at profit.

At the same time, there is a downside to that and it’s you won’t have as much upside potential.

Back to that gold example, let’s say you’re doing a trend following on gold, and gold just skyrockets and you’re only trading that and you bump up your size and everything’s going right.

You could have great returns if I’m doing it and I’m trading gold.

But I’m also trading crude oil. I’m also trading the currency my returns probably won’t be as high as yours because you’re concentrated on something that just happens to be performing well.

The other side to that coin though is what happens if that gold strategy starts to fail.

Now you’ve got all your eggs in that basket and you’re going to suffer.

You’re more likely to get wiped out than somebody who has a diversified portfolio.

To me, it’s all about risk.

Trying to minimize the risk and diversification is one way.

As far as stocks go, I don’t algo trade stocks.

I’ll do stocks for the long term, like retirement investing and that kind of stuff.

But I buy and hold for a lot of things.

The reason is, even with a basket of stocks, a lot of times when the stock market goes down, a lot of stocks go down and there’s a lot of correlation.

In the futures market, you might not get that same correlation.

I tend to avoid that.

Building strategies for stocks is also a little tougher in ways.

Let’s just say you want them to start algo trading a stock.

What are you going to pick?

Chances are most people will do Facebook, Amazon, Google Apple, etc.

Why did they pick those?

Well, those are popular, but they’ve also gone up.

There’s a bias even before you’ve started testing.

That’s why diversifying futures is much better.

Rayner (01:16:55)

Would you say that maybe…That also affects the robustness of a trading strategy.

A strategy is meant to trade multiple markets compared to a strategy that solely trades one market.

The strategy that trades multiple markets, would be more robust in terms of like, less likely to break down compared to the ones that just trade an individual market.

Kevin Davey (01:17:18)

Yeah…

I mean to a degree I think that’s true where you know if you had a strategy that worked in multiple markets.

The one thing it would do is it would give you more confidence for sure so you’d feel…

“Well, this works in a whole variety of markets”

But at the same time, I have found it’s not like an on-off switch where as I said before…

“It’s got to work in five different markets or else I’m throwing it out”

But that’s just what I’ve uncovered over the years where that doesn’t matter.

I have some strategies that work in only one market

Do you know why it doesn’t work in other markets?

I don’t know, but I just keep going with the one it works in.

So yeah, it’s, I think it.

The biggest thing at least for me with that if it worked in multiple markets, it would give me confidence that it would work.

The one thing people have to watch out for though is they’ll try something and they’ll test it on 40 different markets and it works on three of them.

Let’s say they’ll say…

“Well, I’m going to throw the other ones away, and I’ll just focus on those three”

You have to be careful about those three because that doesn’t necessarily mean it’s better.

It just means it worked on three and you threw away all the bad ones that’s just a form of optimization so you have to watch out for that too.

There’s a lot of little subtle things to it where it’s not always that clear on how to do that

Rayner (01:19:07)

How long, based on experience?

How long does a trading system work before it stops working?

Do you have like an average lifespan?

Kevin Davey (01:19:20)

Well, in a lot of the research I’ve done.

What I do is I will simulate running a strategy for three years of live real-time trading.

If it does good for three years, that’s a good lifespan.

I’ve had systems that I still trade that have run fairly well for 10 years.

I also have some systems that work great for one or two years and then kind of fall apart.

I specifically recall a mini-S&P system that worked great for about five to six years.

It was incredible and then at the start of 2022, it seemed like somebody somewhere flipped a switch and said…

“This strategy is not going to work”

Because, If I showed you the equity curve it’s almost not vertical but it’s up and to the right, and then all of a sudden it just fell off.

That was after five years so my general rule what I like in the way I’ve built my process is I plan on three years and if it goes longer, great.

But I feel a three-year period is a good one to get a return on the time you put in and the effort you put in if you were building algos that only work for a week.

Some hedge funds can do it with big research departments where they say…

“Hey, we have something that works for a week and we do a hundred of these things and just keep them rotating”

For a typical retailer trader, that’s not an option. So, I look for longer-term performance.

Rayner (01:21:27)

Got it.

Speaking of trading strategies, how do you get new trading ideas?

Kevin Davey (01:21:36)

Great question.

That’s a question most people who seek me out come up with. They’re like…

“I can’t come up with ideas, I’m not that creative. I don’t know where to find them”

 And my response is always, ideas are everywhere.

Just search the internet for ideas.

Type in free trading systems and they’ll give you rules.

There are all sorts of people offering all sorts of things.

A lot of them are free and you can just…

“Hey, I’ll code it up, I’ll test it. Oh, but I don’t like that. I’m going to add a rule to it or change the rule”

That’s what I ended up doing.

I see something, I put my little spin on it, and I go and test it.

The tough part about that is you have to realize that 90 things out of 100 that you test are not going to work.

They’re not going to be profitable either in backtest or they’re going to have too much drawdown.

Most ideas fail.

It’s kind of disheartening in a way, but it’s also good because it just says…

“Hey, finding good algos is not something that is necessarily super easy”

If it was super easy, everybody’d be doing it and then there’d be no money in it.

Think about it like a restaurant, like a McDonald’s.

If McDonald’s was making $5 off every hamburger they sold and they were wildly profitable, somebody would come around and say…

“You know what, I’ll make a hamburger and I’ll only make $4 profit”

 I’ll be able to charge less.

Then customers will flock to him and then somebody says three dollars and all of a sudden, all the competition lowers the profits and that’s what happens in trading is that everybody’s fighting with each other.

Most ideas and strategies just don’t work long term especially when you include slippage and commission.

You know when you include real trading costs most ideas fail.

That being said, ideas are out there everywhere.

You can go to Amazon and just look at some books and there are books with tons of trading ideas.

You just go and test things and see what might work and what might not work.

That’s the way to do it.

Rayner (01:24:28)

From what I’ve heard, Andrea Unger is one of the World Cup Training Champions.

From the way he does it, if I’m not wrong, he tends to identify the market behavior that he’s trading.

I think he does it through a simple test like buying when the price breaks above the previous week’s high.

If he knows a particular market has a trending behavior, then he’ll probably adopt a trend-following system for that market.

Do you do something similar for yourself?

Kevin Davey (01:25:02)

No…

That doesn’t mean I’m right and Andrea’s wrong.

He’s a good friend and when we get together, we always argue and discuss all sorts of trading-related things.

We have different philosophies on a lot of things.

One thing I always worry about with doing that.

Let’s just say you’d call up a chart of crude oil for the last 10 years and you’d say…

“Oh, hey This looks more like a trending market”

Then you go and you say…

“I’m going to create a trend system for that and test that same data to it”

Well, now you’ve run two tests on that same data.

You ran that first test to determine what to do and it said…

“Oh, the trend will be better”

Then you go and do it. I don’t like doing that.

I like testing something on all the data once, like a one-time test, it either fails or passes.

Because I’m just definitely afraid of all the biases that can happen when you see the data and then make a decision based on that.

You know a good example would be…

Let’s say you’re building a system today for a currency and in the back of your mind, you know that particular currency has been very flat.

It hasn’t had much volatility in the last year.

But you say…

“I’m just going to build a currency system”

Maybe some of the rules you come up with, do something with that volatility. And what has happened, even though you didn’t do it intentionally, you’ve kind of let your knowledge of the markets influence what you’re going to be testing.

You’re biasing your test results a little bit.

So, what it does, is it just makes your back test a little bit more unrealistic as far as what’s going to happen in real time.

Because in real-time, the currency market could go crazy with volatility. How’s your system going to perform to that?

That’s the kind of thing you have to watch out for.

But ultimately, Andrea does things one way, I do things another way, Larry Williams does things another way, and you do things your way.

Everybody has their way, and ultimately, it’s if whatever you do works in real-time, that’s the ultimate judge.

I’ve had people tell me that I’m an idiot for doing certain things that I do.

But it works. 

You can call me whatever name you want; I have data to back up what I’m doing.

That’s the way I would tell people to treat whatever they do, whatever you think and however you think things should be done, make sure you prove it and verify it with real-time results.

Rayner (01:28:23)

Got it.

From what I’m hearing…

You try not to have any bias toward a certain market.

If you have any idea, you just simply take the idea, convert it into a set of fixed rules, and then just test those rules outright and see how it perform.

Kevin Davey (01:28:34)

Yeah…

I’ll admit the one area where I fall off on that is with some mini-S&P futures, mini-NASDAQ futures, and any stock index futures.

A lot of times I’m biased to the long side.

That’s partly because I know stocks have gone up over time, but partly because I think over a long period into the future stocks are going to go up.

But as far as other markets, I like to be able to go long and short with basically what I call symmetric rules.

If it’s a 10-bar high breakout, you go long. If it’s a 10-bar short breakout, you go short.

I try to be balanced that way and I try to get rid of as many biases as I can.

Whether that is always a good thing.

It might make some development a lot harder, but I think it helps with the real-time performance.

Rayner (01:29:45)

I can see where you’re coming from.

By the way, Kevin, it’s almost one and a half hours and I’m not sure if you still want to go further.  Or would you like to wrap it up?

Because I know it’s late on your end, so I’ll leave it to you.

Kevin Davey (01:29:57)

If you have questions and you think it’s worthwhile talking, I can keep going.

Rayner (01:30:03)

Great…

As I mentioned sometimes when I get started with podcasts, I ask questions, things usually exceed the stipulated timing.

Thank you for being so accommodating.

I appreciate it

Earlier we talked a bit about algo trading.

People might be watching this and wondering…

“Man, Kevin, you know, I have no experience with algo trading. How do I get started?”

There are so many tools and resources out there. So, what would you say to such a person?

Kevin Davey (01:30:30)

Well, it’s hard for several reasons.

The first is even understanding that it’s something you can do.

Just as an example, what you should do is take stock of who you are and do you like rules.

Can you follow the rules?

It’s s that kind of mindset the objectiveness of doing things the same way all the time.

A lot of people can’t do that, and that’s fine.

They shouldn’t be algo trading. They shouldn’t even look at it.

You’ve got to look at your personality and see if this fits.

There will be a lot of people who say…

“Well, I like to come up with the rules on the fly and what I’m feeling”

I like to incorporate news events into my decision-making.

Well, then you’re probably not going to be good at algo trading or it’s not going to work for you.

 Maybe a different type of trading will work well. That’s the first thing to do is to take inventory of your likes and dislikes and also then your skills.

If you are bad with computers, now algo trading is going to be tough.

You can write down rules on paper and you can manually calculate things, but computers make your life so much easier in that regard.

It’s a good way to go programming. A lot of people just hear the word programming and they just freak out.

You know…

“I can’t program”

Well, a lot of the programming languages now are pretty simple.

Some are even visual that you can connect blocks and do that sort of thing.

For example, a lot of people use MetaTrader and I can’t program in MetaTrader to save my life, but I found a tool with a company out of Australia that you drag and drop boxes of a moving average box and that kind of thing and you connect it.

You’d make your algo visually, and then you’d hit generate, and it would generate the code for you. Then you’d just paste it in MT4, and it would work, which is cool.

Another thing you can do is, there’s a trading magazine I write a monthly column.

It’s called technical analysis of stocks and commodities.

What they’ll have in every issue is either an indicator, a system, or something, that’s been programmed in maybe a dozen different trading platforms.

So, it’ll be in Trade Station Easy language. It’ll be in Ninja Trader or Ninja Script.

It’s either in the magazine or you can go online and look at it.

What I encourage people to do if they’re scared about programming and they don’t know what language is the best, is pick up an issue of that magazine and then go and look at the code, read the article, and then go and look at the code that creates whatever they’re talking about.

Chances are, some of them, you’re going to look at them and you’re like…

“I don’t understand this computer code at all”

You’re going to be like…

“I can’t program in that.”

But then there’ll be that one language where you’ll be like…

“Oh, okay. I can understand that”

That’s probably the one you should then pursue.

That leads to the next point.

You have to get a trading platform.

Whether it’s Ninja Trader. I use Trade Station, there’s multi-charge, there’s a lot of TradingView, there’s a ton of stuff out there.

But you want to get a platform that can do all the testing that you need to do.

You want to do forward testing you know some of these terms will just go over people’s heads but you know you should investigate how to do algo trading, and then look for a platform that will support you in that.

Then you pick a platform and start learning it and see how to do things.

It’ll take a while to go from newbie to…

“Hey, I’m comfortable with the trading platform, writing some trading strategies”

But once you get there, then the big thing becomes.

How do I develop trading strategies?

Unfortunately, almost all the trading platforms out there, they’ll encourage you…

“Oh yeah, program your rules”

Then when you go to put it on a chart to see how it does, they’ll pop up a box where you’re given the chance to optimize a moving average length.

What most people think is…

“Well, hey, that’s got to be a good thing. I’ll find out, I’ll tune the system to what works best”

I’ll get a great looking-back test, that’s what people do.

The trading software encourages it because when you’re done, you’ll see a nice backtest and you’ll think…

“Oh, this is great. This will be so easy. I’ll just go live with this”

That’s the wrong way to develop a strategy.

Once you get the basics of…

“Hey, I got a platform. I know a language. I’ve written some strategies, some simple strategies just to test things out”

Then you have to focus on building strategies properly.

Then there’s a lot to that. Once you do that, you have to learn how to automate it, which a lot of platforms are pretty easy, and start trading it.

You’ll end up working on your psychology more for things like…

“Oh, should I turn this algo off?”

You know, last week it lost money and things like that.

I’ve kind of taken you through a bunch of steps there.

They’re not necessarily super easy, and they will take you some time, but it’s a commitment and you know it.

Unfortunately, with trading and I’m sure you know this Rayner, It’s so easy for anybody to say I’m going to start trading.

I saw a YouTube ad.

“I’m going to start trading”

They go online open an account, and do a wire transfer of a thousand dollars into an account.

The account gets funded.

“Hey, now I can buy and sell, I can start trading”

Well, of course, they make it seem easy, but that’s how people view it.

“Oh, it’ll be easy to make money”

They make that leap from, it being so easy to open an account, it should be easy to make money…

Whereas becoming a trader and being successful at it is the hardest way to make easy money.

To me, trading is a lot harder than what I was doing when I was in the aerospace world and just to give people an example, I was in charge of quality assurance for a company so we made components for a fuel pump.

One dimension, if it was off one-thirtieth of the thickness of a sheet of paper.

Take a sheet of paper and somehow cut it into 30 slices of width.

I mean, you’re talking about such small values. If it was off by even a ten-thousandth of an inch we had to scrap that particular part.

If one escaped with that, could cause a failure.

It was like high stress.

Every day I’m thinking…

 “Are we doing the best we can to make sure nothing bad gets out?”

So as stressful as that job was and as tough as that job was, trading is harder.

I tell people that, and they’re like…

“Oh, he’s full of it, he’s lying”

I wish trading was easy.

Even after doing this for 30 years, I wish I could say…

“Oh, well now it’s easy”

 Man, I will just be on the beach most days sipping a margarita.

It’s not that easy.

There are always new people coming in with new ideas and new tools, and they’re constantly pushing everybody else.

It’s a real dog-eat-dog world.

Keep some of that in mind that it’s going to be a journey and it’s going to take significant effort to succeed in it.

That’s true with all trading.

I’m not trying to pick on algo trading or anything.

You want to be a good discretionary trader. You’ve got to work at it.

Rayner (01:40:45)

I think that’s true.

It’s true for trading, business, life, and anything worth succeeding at.

It requires time and effort because if not, everybody will do the same thing.

Then your so-called advantage, your edge is eroded and you know, you’re going to be just like everyone else.

The commitment and the effort have to be there.

You have given a very good realistic picture of what trading entails.

I don’t think most magazines are happy to publish what is just said.

Scare away all the audience.

No one’s going to subscribe to the magazine.

Just one thing to add, because I can’t program.

What I do, in case the listeners are interested, is I work with the programmer very closely.

We have a very close relationship.

Whenever I have ideas, I just feed him the rules.

Because I have the ideas. I need to translate it into a set of rules.

Then he executes the programming part.

I just fact-check to make sure all is well.

That’s another option for people who are interested in going down that route.

But if not…

Hey, learning a new programming language, like what Kevin has mentioned, sometimes you just look at the code. You kind of like, intuitively, you would be like…

“Oh, this is talking about the moving average”

I guess you have to find the right language that suits the person.

Kevin Davey (01:41:57.13)

I was just going to say, working with a programmer is an option.

It’s the one thing people have to watch out for.

Like I said before, most ideas fail.

Your programmer is going to generate a lot of stuff for you that’s going to be garbage and it’s not his fault.

It’s just the way it is.

Rayner (01:42:22)

It’s my fault, yeah, it’s my fault.

Kevin Davey (01:42:29)

A lot of times when people say…

“I’m the idea guy, I’m just going to give it to a programmer”

A lot of people unfortunately get it in their heads that whatever idea they come up with and I guess this applies to people who use programmers and who program themselves.

They have in their mind that their idea must work and then they become sort of emotionally attached to it.

I’ve got this theory of when this pattern happens with these indicators, this has got to work.

What they’ll do is they’ll make that a reality by just changing rules, adding filters, and constantly tweaking it until they get something that works and it only works in backtest.

People have to watch out for that too.

You’ve got to treat any idea you come up with as just…

“Hey, this is an idea. May or may not work. If it doesn’t work, I’ll just move on to the next idea”

That’s how you got to do it.

Rayner (01:43:36)

The emotional detachment, right?

I believe that’s what you’re referring to.

It’s just a loss let’s move on to the next trade.

“Oh, it’s just an idea. Let’s move on to something else”

Kevin, speaking to you, you have a lot of passion and love for trading.

Let me just bring you to the other end of the spectrum.

What do you dislike about trading?

Kevin Davey (01:43:38)

I dislike the frustration of just not being able to develop a system or a new strategy at will.

Some markets are hard to develop strategies for and that gets frustrating.

Drawdowns are killers.

Last year I had what was a great performance year.

Was almost a triple-digit return percentage-wise.

I went back and looked at it, and when I looked at the month-by-month results, I had four losing months, and actually, I was in drawdown six months of the year.

Meaning at the end of every month, I’d look at my equity compared to wherever the peak equity was, and at the end of six of those 12 months…

I said…

“Hey, at some point earlier in the year, I had more equity in my account than I do now”

That is demoralizing.

Even though I had a good year, I still had lots of losses and lots of days where I lost money in weeks and months and it gets to you.

Everybody’s so used to…

“Okay, well I’ll go and work wherever. I get a paycheck; I’m paid every day”

But trading, hey, I go to work, and I work eight to ten hours and I lose money.

I pay the boss instead of the boss paying me.

How does that work?

That becomes part of just the downside of trading.

The fact, at least for me, it never gets super easy, where it’s just, oh man, now I can sit back.

It’s hard now. It was hard 20 years ago. Even though I like to think, I know a lot more than I did 20 years ago, yet…

It’s not like I know five times as much.

So, hey…

“I better be five times as good of a trader”

Doesn’t work like that.

That’s some of the downsides to it, but those are, except for the drawdown part, those are fairly minor.

The drawdown part is just something that you just have to learn to live with and it’s frustrating.

Anytime you lose money. It’s not a happy day, but you have to realize that’s just part of the game.

 If you can’t do it then maybe look at something else.

Rayner (01:47:01)

That’s why I believe that someone can be trading full time but it helps immensely if trading isn’t their only source of income.

This way, psychologically, I feel that they are more prepared to handle the drop-down knowing that…

“Hey, if this month’s trading doesn’t do well, guess what? I still can put food on the table”

I have another source of income coming in to help me tide through whatever I’m going through.

That’s kind of my philosophy.

A lot of traders that I come across, don’t believe it.

Having multiple sources of income helps with trading psychology immensely.

Kevin Davey (01:47:40)

Yeah…

Along those lines, I did an in-person event a few years ago, and as part of it.

I wanted to do a roundtable with anybody who identified as a full-time trader.

I said everybody wants to aspire to be a full-time trader.

There were like five or six people who came up and said…

“Okay, ask me questions”

I was one of them. The one thing they had in common, five of the six people had other income streams.

Just like you said.

For me, I trade full-time, but I also teach so I make money from teaching.

There was another guy who sold signals on a website there was another guy who was a commodity trading advisor so he’d invest other people’s money.

Of the six people, five of them had some other source and it was trading-related.

One guy was an ex-Enron trader.

For those of you who remember Enron the big energy firm he is just a full-time trader and he does very well.

But he was the only one of those six, so what you’re saying agrees with what I’ve seen out there

Rayner (01:48:59)

Alright, Kevin…

Also, I think during the conversation at the start, I heard you mentioned some setbacks and challenges you faced.

Can you share with us what are some of the challenges that stick out to you like a sore thumb?

What do you have to do to overcome it?

Kevin Davey (01:49:15)

Probably the biggest challenge, especially starting, was just starting with not enough capital to withstand drawdowns.

I guess a related part of that would be not expecting the drawdowns that happened.

Way back in the day, I would get $5,000 together to open an account or fund the account.

I never expected to lose 30-40% of that before making some money.

That turned out to be just a huge setback.

The reality is if you look at professionally managed futures, funds, and professional traders who publish results there are some databases out there for commodity trading advisors.

You’ll see a lot of them have had 40, 50, 60% max drawdowns.

That was something when it occurred, I never expected so that was a huge setback.

A huge deflator because you think…

“Hey, I’m going to make money at the markets”

All of a sudden, you’ve lost half your money.

That was probably the toughest thing to overcome is to realize this is probably going to happen.

My rule of thumb is whatever drawdown you think you can handle; the reality is you can probably handle about half of it before you start going crazy.

Let’s just say, I can handle a 50% drawdown.

What’ll happen is you’ll be trading, and this happened with me. I’d get to about 25% drawdown. I’d start to wonder…

“Oh, are these algos still good? Are they broken? Should I stop trading?”

Then it goes up to 30, 35%.

What do I do?

Should I cut back?

Should I turn something off?

Should I just stop and then by the time I got to 45%?

I can’t handle it I’m done and you would never even get to your 50%.

That’s what happens with a lot of people and it certainly happened with me so learning to handle drawdowns was the biggest setback. The biggest challenge was learning to overcome those.

Rayner (01:52:10)

Speaking of drawdown, I think one thing that is rarely mentioned is how much of your net worth are you trying to put in your trading account.

If you’re going to put 100% of your leverage, then the little bit of drawdown is going to make you have sleepless nights.

But if, let’s say, your trading account is a fraction of your net worth, maybe 10%, 20%, 30%, depending on how experienced you are, that helps the drawdown at a certain level as well, since not all your eggs are in one basket.

Kevin Davey (01:52:35)

Yeah.

I have some students I’ve worked with who said…

“Yeah, I’m going to put everything on my retirement into trading”

I always caution them. I’m like…

“I don’t”

They’re like…

“You don’t?”

I mentioned it earlier, I have stocks in my retirement funds, I have real estate, stuff outside of just trading funds.

It’s all a diversification method.

If I was a hundred percent confident without a doubt that I could double my money every year in trading without any drawdowns.

Well, then I put everything in trading because that would be a no-brainer, but the reality is nobody knows that for sure.

You have to watch out for it.

I see this a lot with people who try to go…

“I lost my job; I’m going to go full-time trading”

But I have an account of $100,000.

I’ve also got to get my living expenses out of it.

I always caution people on that and say…

“Well, just remember if you have a down month, and then you have to take living expenses out of it, now you’re in worse shape”

Now the pressure’s on.

Are you going to be able to handle that?

A lot of people can’t.

You can put a percentage, whether it’s 10%, 30%, whatever it is, but I don’t think I’d put all my money into anything because you just don’t know the future.

You could say…

“Oh, hey, I’m buying Gold. Well, let’s just say tomorrow somewhere in South America they find this gold mine where there’s so much Gold”

That gold is going to be worthless because there’s so much of it out there and it’s not going to be a precious metal anymore.

You don’t know. It’s a possibility.

You have to be careful.

Don’t put all your eggs in one basket as the saying goes.

Rayner (01:54:57)

The fun fact is there’s a lot of gold actually in space.

If humans find a way to extract that gold in space, I’m not sure which planet back to Earth I guess the price of gold we’ll see It’s going to be interesting

Kevin Davey (01:55:09)

Yeah…

I’ve heard that about asteroids, there are companies out there who are trying to figure out how to snatch asteroids mine them, and bring them back. Because of the precious metals

It’s kind of interesting

Rayner (01:55:29)

Let us move on to the closing section because you know, as I promised, I’m going to keep these two hours there.

What does your daily routine look like right now?

Kevin Davey (01:55:34)

My daily routine since I also teach a course.

I wake up, I help get the kids ready for school or at least wake them up.

They’re all teenagers so I don’t have to get them ready but I have to bang on the door sometimes to get up.

But the first thing I’ll always do is check my positions for my automated systems and just make sure things are in sync.

You know people have this mistaken idea that…

“Hey once I automate something everything will work fine”

There are all sorts of things that go wrong, you know orders get missed because there’s an internet disconnect.

You know things get recalculated sometimes there’s all sorts of stuff.

You have to check your positions.

If I go out somewhere, I either have a laptop with me or a tablet or my phone where I can get into my trading and I can see.

Am I synced up with my positions and all of that?

As I said, since I’m teaching a course, I’m usually answering student emails, doing things along those lines, or creating new course material or research.

I’m in a unique position because I can do research both for my trading and then the real good stuff I can share with students.

Like back a few months ago, I finished up a study where I ran 50 million backtest. It took months to run, but I got some really neat results out of it.

Then I used that in my trading.

I was able to also share it with students.

Ongoing research and strategy development, that’s a big part of my day too.

But the other nice thing, doing it full time, I do it from home.

My office is always here, that’s good and bad because my time it’s almost 11 p.m., and here I am still working.

But…That’s what happens.

I wake up in the middle of the night, I might work on a trading system at three o’clock in the morning.

A lot of times my schedule becomes kind of chaotic because I just work whenever I feel like it.

At the same time, I have the freedom that…

“Hey, I don’t have to do anything today other than monitor my positions”

I can go have lunch with a friend and make it a long lunch.

I could make a doctor’s appointment, and not have to worry about things.

There’s a lot of flexibility in being a full-time trader along with the responsibility, but you know, if I had to boil it down, I would say roughly half the time I’m working during the day is working on my trading either through monitoring positions.

Which typically doesn’t take that long or just trying to figure out new ways to do things.

Which includes approaches, and new strategies that I’m testing.

Rayner (01:59:08)

I love it.

On top of that since your children, they’re all teenagers, they don’t need your attention compared to when they were young right?

Kevin Davey (01:59:16)

Right.

Which is good and bad.

Because you love the times when they needed you for everything and they’d see you come home from school.

They come running to you.

Now it’s like I have to hunt down in the house.

Where are you?

“Oh, you didn’t even say hi to me today”

I guess there’s a balance between that and part of getting old with the kids.

Rayner (01:59:47)

My time will come soon.

Another question I have for you, it’s a pretty fun question, I like to ask this. What has been something that you’ve purchased for below $100 that has made a big difference to your life?

Kevin Davey (02:00:03)

Hmm, something that I’ve purchased below $100.

Well, this was right around $100, and this was a recent purchase.

I got it during Amazon Prime days.

It was an ice maker and sounds weird because everybody has one. But this creates a little chewy nugget.

If during the video you see me drinking.

I’m drinking some iced tea with those little ice nuggets and they’re chewable.

It’s just something I’ve always chewed ice my whole life, you get that hard ice and it almost breaks your teeth.

But this is like chewy ice.

I remember telling my wife, I was like…

“Hey, do you care if I buy this? It’s around $100”

She just kind of looked at me like…

“You’re buying an ice maker?”

I’m like…

Yeah, but it’s…

Seriously, but now my kids are kind of like…

“What are you doing?”

I said, try it and they’re like…

“Oh yeah, it’s chewy ice”

It’s like one of those purchases that is just so bizarre, but it’s like really good. I’m like making cups of ice every day just so I can chew on it.

It probably helps me keep the calories down from eating food.

Maybe instead of eating food, I’ll just chew ice and I get the same effect. I don’t know.

Rayner (02:01:37)

Be a great investment. I can see the joy on your face already as you’re telling me about this ice maker.

Kevin Davey (02:01:42)

Yeah, it’s a pretty neat little thing.

Rayner (02:01:47)

Before you go, Kevin, where can the audience find you if they want to learn more about algo trading, to learn more about what you do, where can they find you?

Kevin Davey (02:01:55)

Sure, you can go to my website.

It’s:

www.kjtradingsystems.com

If you go to YouTube, you can just type in my name,

“Kevin Davey”

My channel will pop up.

It’s called “Algo Trading with Kevin Davey”.

You can also find me on Twitter.

My handle is “KJTrading”

But those are all easy ways to get ahold of me.

Probably the most popular with you viewers will be the YouTube channel.

As I said, if you just type “Kevin Davey”

I should be like right up at the top.

There are a couple of other Kevin Davies out there.

One’s a brewer, he brews beer, and one’s an actor.

But I think I know I’m the only “Kevin Davey trader”.

So even if you did “Kevin Davey trader”, I’ll pop up.

Rayner (02:02:51)

Yep, I believe it should be quite easy because I tried that myself.

“Kevin Davey trading”

You are at the top of the list.

It shouldn’t be difficult to find you.

So, Kevin, thank you so much for your time. I appreciate it. I know it’s late at night.

I mean, close to midnight for you and you’re still sharing such deep techniques and strategies.

On how you run algo trading.

Once again, Kevin, I appreciate your time.

Thank you so much for being on the show.

The first guest, I appreciate you and you know, being so quick to respond.

Thank you so much once again, Kevin.

Kevin Davey (02:03:11)

Like I said, Rayner, thanks for having me on, and thanks for me being the first.

I mean I’ve been following your YouTube channel for a while.

I have a lot of my students who mention you and you’re a pretty popular guy.

It’s just great to be a part of this.

I appreciate it.

Rayner (02:03:41)

Pleasure is mine, Kevin.

Have a great evening.

We’ll be in touch and I will talk to you soon.

Bye, my friend. Take care.

Kevin Davey (02:03:46)

All right, thanks.