Interview Transcript with Erich Senft

TradingPub Admin | October 30, 2012

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Last week we hosted a special interview session with Professional Trader and CTA, Erich Senft.  Erich shared tons of great info so in addition to making the recording available, we have posted a copy of the transcript below.  Enjoy!

Interview Session: Erich Senft - Transcript

Morgan: I’m going to ask Erich some questions, and then open it up for any questions you guys may have. Our speaker today is Erich Senft from Erich has spoken at the TradingPub a couple of times. He is actually doing a special webinar in a couple of hours, so we will talk to him about what he will be covering there.

Morgan: Erich, if you can, tell us how you got your start in trading.

Erich: I actually got my introduction into the investment world when I was fairly young. I tell people that my first experience was with my cousin, Marvin, when the Hunt brothers began to rally in the silver market. The silver prices were going through the roof. My cousin Marvin, being more ambitious than I was, began hoarding quarters for their silver content. Started exchanging dollars for quarters for about a week until my uncle told us that the government had stopped putting silver in quarters in the 1950s. That was my intro to the world of investment. Fast forward about 15 years; I got a flyer from the Ken Roberts Company in the mail. Trading and commodities was always something I was interested in. I applied for the course and subsequently opened and account, and the rest is history. That was my intro to trading.

Morgan: What markets do you primarily trade and why? What led you to trade those markets instead of stocks.

Erich: I suppose it had more to do with the information I received from Ken Rogers. He was a primarily commodity based course. I didn’t know too much about the stock market. We never really had securities investments as a kid. I guess that since my training was through Ken Rogers, I have always focused on the commodities markets because you can buy them or sell them unlike stocks where people are always looking to buy low and sell high. And futures and forex is very similar to the commodities market. Of course Futures are heavily leveraged, so it doesn’t take a lot of money to play. You can control a lot of soybeans etc. for a relatively small amount of money. I primarily traded corn and wheat, but occasionally I would take a soybean trade. But, corn and wheat were really the markets I was most interested in. Remember this was before daily charts were available, so you got your info from the newspaper or television. This was long before free charts were available. A lot of people don’t realize how far we have come. Sometimes I would phone my broker at the end of the day and see where the markets closed. I would literally plot it on my paper chart, the days’ activity. I would actually get my charts weekly in the mail. So I was primarily a position trader because daily trading is virtually impossible that way. So I really just stuck to commodity trades like corn and wheat, but every once in a while I would take a currency trade. Sometimes the Canadian and Aussie dollar. Sometimes I’d do cattle.  Always did well with cattle. Sometimes I would do sugar. Those were the core of the markets I started with. When I’m day trading I focus mostly on the index markets, mini Dow futures and Nasdaq futures. I do that because of the size of the tick value. The Dow futures (ym futures) and Nasdaq futures (nq futures) mirror the S&P, but you can take twice as many positions because the Dow and the Nasdaq are only $5 a tick and the e-mini is $12.50 a tick. So it’s going to cost you twice as much to trade the e-mini as opposed to the ym futures or nq futures. And that is how you get the biggest bang for your buck, by trading a smaller tick amount instrument. A lot of people don’t realize that. A lot of people think that the thing to do is to trade something expensive. Most cases you’re better off taking a smaller tick value instrument. I also watch crude. It has to be a pretty sweet set up for crude because it’s such a crazy market. I also watch bonds, and that is kind of to see what is going to happen in the stock industry. If bonds are going up there is a good chance the Dow and Nasdaq will go up. And if crude is going down, there is a good chance stocks industries will go down as well. So you have a direct relationship and you have an indirect relationship. The reason I like to look at bonds, and I will take bonds every once in a while even though it is $25.31 a tick, the bond traders are probably some of the smartest traders in the world. You are not going to fool a bond trader. If you see the e-mini, Dow, or Nasdaq go screaming off in one direction, and the bonds aren’t moving, there is a pretty good chance that the move will not be sustained for very long. Bond traders are a pretty tough lot. The oil traders are tricky boogers. Often time’s crude will lead and you will see crude take off in a direction and there will be a little bit of a stutter step in the mini Dow or perhaps the Nasdaq. You will have just that little bit of tip off that maybe a move is coming. So that is why I watch those two. I also used to trade the stocks 50, but I don’t so much anymore. That is the European Dow Jones. It is a very good market. The Europeans are very methodical traders. You don’t see a lot of nonsense when you are looking at a chart from the European Market. They are very respectful of support and resistance. That’s my trading philosophy. I look for support and resistance areas and trade off of those. The stocks 50 will trade at 10 euros a tick. So, when you are making a profit, you can be making another 20-30 percent on your investment just from the currency exchange. But it can also go the other way. Those are the markets that I’m most interested in. I’m looking at whatever is moving.

Morgan: Many times when traders start out, they initially struggle. Did you go through that? Did you have any major losses that you had to overcome?

Erich: I took my share of losses. I busted at least 2 accounts before I started making money. It was all of the things that you hear about, but you have probably heard the expression, “Your experience gives you the test first and the lesson later, and you keep getting the same test until you learn the lesson.” Well that was me. I was a little bit of a slow learner. And I don’t know what it is about traders, but a lot of us are wired to be contrarian by nature. We want to go against whatever the market is doing instead of saying, “Hey here is a trend, let’s go with the trend.” It took me a while to break that. A lot of times you look at the trend and you can’t define the trend. Go with whatever looks the least obvious. In other words, a bearish market will usually look bullish, and a bullish market will tend to look bearish. Unless there is a well-defined trend and you are obviously in an uptrend. A lot of times, your best sell signals will look very bullish when they start and vice versa. So, I don’t really believe the conspiracy thing that the market is out to get me, but I do believe that the market does repeat itself in some ways. I do believe that buyers and sellers hold off on their orders knowing that the inexperienced traders are going to get in on the wrong side of the trade. That will just make it easier for them to realize a profit. But yeah, I blew through two accounts before I finally learned how to manage my risks and not to be so anxious when I’m trading. The weak trader is always anxious, so don’t be anxious. I have been doing this for 20 years, and you are always going to get another chance. It is human nature. We are afraid that we are going to miss out on making some money, but so what if we miss one. I’m watching a dozen charts each morning, and surely out of a dozen charts I’m going to miss something. It is a hard and expensive lesson to learn, but you have to get over being anxious and over trading. Over trading is a huge one. You have to learn how to control your risk. Risk control is not risk reward ratios. Yes I was one who told people you needed a 3 to 1 or 2 to 1 risk to take the trade until I started trading. Then I realized, hey, this doesn’t work because I don’t know where the market is going to go next. But no one knows where the market is going to go next. Yes, you can give it your best guess, but you shouldn’t base a trade on what you don’t know. The whole thing about trading is risk control. If you can control your risk, you can make money, but you never want to over capitalize on a losing position, and you never want to under capitalize on a winning position. That is all about position sizing. I also started keeping a trading journal. If you don’t keep a trading journal now, you should. I just have a 3 ring binder, and I write down which trades I take and why. It won’t take more than a few weeks for a pattern develop, and it won’t take you long to realize which trades are or are not working out for you. It is the best thing you can do to shorten your learning curve. I hear a statistic once. I’m sure it was made up, but it just kind of drives the point home. We have all heard that 90% of traders lose money, so that leaves 10% that is making money. So what are those 10% doing? Well someone told me that out of the 10% of people who are making money, 90% of those 10% are keeping a trading journal. That means that only 1% of traders are good enough to trade without a journal. So, unless you figure yourself to be in that 1%, do yourself a favor and keep a trading journal. It is the best and cheapest learning tool you could have. You will recognize when you are overtrading, and you will recognize your better set ups because you will be making notes of them. You will be analyzing your bad trades, and the next time the market flashes you that signal, you will say, “Hey, wait a minute I took that trade a couple 3 days ago and it snookered me, so I’m not going to take it this time.”

Morgan: One thing, it was interesting that you brought up the trading journal, and I was actually going to ask you to tell us about your trading journal, and you went ahead and did that. It’s a big thing. I have had people approach me before and say, “Hey, I’m struggling with my trading. Can you help me?” I say, “Ok, send me a copy of your trading journal and it goes silent because you know they haven’t been keeping one. In pretty much anything you have to review your performance to see how you can get better. Just like athletes watching film and analyzing how they performed and ways they can improve that. So I really appreciate you bringing that up.

Morgan: When you look at trading, whether it is discretionary trading and you think about how some people trade with just complete discretion, by watching the market or just going with their gut or going with the technical setup, as far as kind of implementing a setup. I know you have kind of been working a lot behind the scene over the past couple of years on the Diversified Trading System. Tell us a little bit about that and what you guys are trying to accomplish with that.

Erich: Yes, Diversified Trading System or DTS for short. It is a comprehensive trading system. What we found is that most trading systems out there are severely lacking because to have a complete system you need three components. You need to have an entry. You need to have an exit. You need to have money management. Most systems out there only look at the entry signal. And most traders mistakenly believe that they only need a better entry signal. They think that if they are losing money, it is because they don’t have a good entry signal, but that is not the case. In fact, you can make money with a 50/50 system, which is like flipping a coin, if you have good money management and a good exit strategy. You really need all three, and this is what we were after with DTS. We were trying to develop a complete system for people to use that is very simple to use, and it is very tradable. It is very comprehensive in the sense that it actually analyzes the market from 3 different perspectives. DTS is comprised of 3 signal generators. There is the hawk micro-scalper, the falcon swing trader, and the eagle trend trader. So we are looking for scalp trades, swing trades, and trend trades simultaneously. Each of the signal generators has been tweaked to recognize the specific market characteristic. So, if a trend is emerging, you are going to get a warning in the eagle saying that you have a trend developing in whatever market it is that you are watching. The same thing goes for the scalp trade. So, it is actually possible for you to have a trend trade in the mini Dow futures, and you can be sure the mini Dow futures are heading lower, and you can actually get a signal to scalp it to the up side on a short term reversal. So that’s what DTS does. It looks at the market from different angles and it looks for scalp trades, swing trades, and trend trades. But it also gives you the complete package because not only does it have the signal generator, but it also has the profit manager: which is an automated stop strategy. And you get to choose from a dozen different stop strategies. You can tweak them to your own rick tolerances, so you can make it more or less aggressive and it is fully automated. So with just a click of the mouse, it will make your stop live. I mentioned earlier that I watch a dozen charts each day, and that is how I am able to do that. I can actually put on a trade, say in the NQ, and turn on my profit manager and go watch crude oil knowing that the profit manager is going to handle my open position. And that will allow me to look elsewhere for another opportunity. And that last component in money manager. With DTS we also have what we call the risk manager. Now in my opinion the risk manager is the single most important tool because it does position sizing for you automatically. So, with the risk manager, you are never going to over capitalize on a bad decision, and you are never going to under capitalize on a good decision. So, you are never going to lose more than you can afford to lose on a bad trade, and you’re always going to maximize on what you can with a good trade. You know, we have all heard, “Cut your profits short, and let your profits run.” But no one ever tells you how to do that. It is fantastic advice, but how do I do it? This is how you do it. You have to limit your risk exposure to only a certain percentage of your account, ideally, 2%. So that means that your risk stays constant in any trade, and you adjust your position size so that your risk amount stays the same. Quick example: Say you are looking at a position in the emini S&P, and you want to go long. And from your entry to your exit, you are looking at $500 risk. So let’s say you are trading on a $25,000 account, and you want to risk 2% of your account. That is $500. So that means you can only take one lot, or one position on that trade. But let’s say you get another set up in the emini S&P, and now it is going to cost $100 from your intended entry to your intended exit. Well now, because your risk amount is $500, you can actually take 5 contracts on that trade. If it doesn’t work out, that’s okay. Yes, you have lost $500, but you haven’t lost more than you can afford to lose. See, what most people do wrong is that they invest far more than they can afford to lose. For instance, when I started trading, I started with a $10,000 account. My first trade was a $1,500 risk position. That is insane; I was risking 10% of my account. Most people will do that without thinking twice, but what most people don’t, and this is what professional traders and money managers all know, is that there is a very real possibility that you will take 10 losing trades in a row. So, if you are routinely risking 8, 9, 10% of your account, and you take 10 losing trades, you don’t need to be a mathematician to know that you just had an 80-90% draw-down on your account. In other words, you busted your account. But if you are only risking 2% of your account, which is the ideal number, anything less than 5% is considered prudent, and you hit that streak where you hit 10 losers. Well you only have a 20% draw-down. Yes, it is going to hurt, but it hasn’t wiped you out. That is the whole point and that is what people don’t understand. Most people risk far more than they can afford to lose, and then they wonder why they blow up their account. So, if you want to know the real secret to trading, control your risk. So that is what DTS does for you. It gives you signal generators, it gives you profit management or exit strategy, and it gives you risk management. It is the closest thing to a fully complete trading system that I have ever seen, and I have seen a few. We have designed it to be as simple as possible. There is very little thought or discretion involved in taking the signals. It is not a black box and gives you every signal, but we have designed it to be as simple as possible in that if you get a buy signal you buy, and if you get a sell signal, you sell. You get the correct position sizing, and at the end of the day, hopefully you are making money.  It is quite exciting and I am very proud to be involved with it.

Morgan: Real quick, we have about a minute left. You are joining us right after this in the same room, so talk to us real quick about what information you are going to share with us this afternoon.

Erich: Well it’s going to be a little more of some of the things that I just went over, but mainly, I will discuss what you need to look for when you are developing a system. The 3 components of the system: the entry, the exit strategy, the money management and why it is important. Mainly, the kind of things that we look for in the indicator warehouses when we are putting a system together or when we are evaluating a system.  That’s what we will be looking at, so if you are either evaluating a system or looking to design your own system, what kind of things you should be looking at. That is what we will be discussing.

To view Erich's Session on Cracking the Code - Erich Senft Recording


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Risk Disclaimer: Past performance is not indicative of future results. Futures trading involves substantial financial risk. Views of guest commentators do not represent those of Article intended for educational purposes only and not meant in anyway as a solicitation to buy or sell certain securities. Please consult your personal financial adviser before using this information for your own trading purposes.