Ep. 200: Tom Basso Interview #3 with Michael Covel on Trend Following Radio

Tom Basso
Tom Basso

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Today on the podcast, I speak with Tom Basso, the trader most famously known as “Mr. Serenity” in Jask Schwagger’s book New Market Wizards. Basso was a stock trader and president of Trendstat Capital Management, but is now retired.

In this interview, Basso and I discuss location independence, using mental exercises to optimize yourself, and Basso’s daily routine as a trader. We talk about Basso’s 39-year track record as a trader and discuss his strategies.

We get into the psychology behind trend following trading, how to identify difference between a regular drawdown and something going seriously wrong, and why the willingness to lose small amounts of money can have massive benefits in the long run. Basso also talks about why trend following does so well during black swan events.

This is Basso’s third time on my podcast. I hope you enjoy!

In this episode of Trend Following Radio:

  • How to use mental exercises to improve yourself as a trader
  • Why the tolerance for losing small amounts of money can make you almost invincible
  • Tom’s daily trading routine: how to ensure you don’t spend the whole day making trading decisions
  • Why understanding strategic planning is key to being a successful trader
  • Trading for clients vs. trading for yourself, and the regulations that go along with that
  • Understanding the difference between a normal draw down vs. something really going wrong
  • Separating facts from opinions, and why it’s important in trend following trading

Mentions & Resources:

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MICHAEL: Today on the podcast I have Tom Basso. Tom was famously featured in Jack Schwager’s “The New Market Wizards,” a great chapter if you have not read it. In fact, if you have not read it, what’s wrong with you? There must be something wrong with you. Tom has appeared on my podcast several times, and I welcome him today. Please enjoy.

TOM: Michael?


TOM: Hey, gotcha. Finally. Jeez.

MICHAEL: That was weird.

TOM: You know what, I’ve got maybe – have you updated your Skype? You’ve got a brand new picture where you’re speaking in front of some Asian-looking letters, and I don’t know how Skype works – I’ve got a link to your previous picture, and I don’t know if it’s the same place as this picture, but maybe – I don’t know. Anyway, I’m also on Windows 8, and I’m never clear on how Windows 8 seems to have this concept of you could go to your desktop and do things like in normal Windows, like 7, 6, and 5 and all the other ones, XP and all the other Windows varieties, but 8 has this other version where my Skype is in the whatever you call this stuff that comes over on the right side. I have no idea. But I had Skype up this whole time, and I never heard anything come through. Anyway.

MICHAEL: We made it.

TOM: You’re very clear.

MICHAEL: Yeah, you sound FM radio good. So how goes life here in the last year?

TOM: Oh, life is fantastic. I just came from hitting some golf balls over at Pinnacle Peak and really enjoying – like tomorrow, I’ve got a round with the guys. We’ll have some fun there. I just planned a trip to Tahiti, working on the plane flights this morning. Getting my year-end tax stuff done. Everything is wonderful, really.

MICHAEL: Yeah, Tahiti. Have you been before?

TOM: Never. First time. I traveled the world, as you know, as a currency trader. Most of my clients were everywhere but Phoenix or St. Louis, which is where I was. But I have – well, now I’m getting – calling your landline – I’m getting all sorts of messages from you all of a sudden. All right. Yeah, but what ends up happening is I only traveled to money centers, usually. But I traveled to a lot of the money centers around the world, so I was in Geneva, London, New York, Chicago, Tokyo, Hong Kong, those types of big money centers. So places like Tahiti that don’t have any banks to speak of that would have currency trading were not on my itinerary, so I’m taking this opportunity with my wife to go – when I travel, I go to some of the place I’ve never been.

MICHAEL: Sounds like a plan. I will be in Asia again for 2014. I’m in the States right now; I’m in Virginia, and I plan on doing a little more of the obscure type things in this upcoming year as well.

TOM: I’ve been meaning to ask you, why the Asian thing? Did you always have a love of Asia, or is that business, or what?

MICHAEL: Well, the first four or five months of 2013, I probably gave 40 live presentations in all the money centers, to probably many of the same types of folks that you’re talking about, and I had a good time in Saigon, which wasn’t part of the itinerary, and then I went back and I spent six or seven months there. So I decided in 2014 to go give it another shake.

TOM: Wow. And with the internet, you can upgrade from anywhere, as I was a good example of over the years.

MICHAEL: Yeah, yeah, it’s awesome. I think this location independence – I feel like I’m the front wave of location independence.

TOM: You are. And really, I don’t know that the U.S. – as long as you’re comfortable in another country, I feel like the U.S. has lost quite a bit of its dominance as the place to probably live, due to lots of things. But the rest of the world is out there, and there’s lots of opportunities, and U.S. is going to get, I think – my prediction would be an increasingly dangerous place to be.

MICHAEL: I think as you say that, that’s probably, from the physical, the mental, the economical, the political, the whole nine yards.

TOM: Yeah, exactly. And on the other side, Vietnam’s probably going crazy.

MICHAEL: Yeah. I used to joke when I’d walk down the streets when I first got there, and I would look at some of my friends, I’d be like “Where are the communists?” They would not get the joke, because all I would see was commerce everywhere.

TOM: Yeah, exactly.

MICHAEL: Here’s the first question I have for you today, and a bunch of folks on the internet also had some questions too. But I think one of the things that’s interesting about you – and I think this is somewhat what you’re known for, at least by reputation – but you’re very good-natured. And there are a lot of people in the industry, so to speak, and maybe traders, who are sometimes – they lose sight of the happy part of life. They just lose sight of life, in fact. They get so fixated with the screen and the idea of making the millions and what they think will come with all the millions, and they get caught up in that.

You’re so good-natured, so I guess my first question is, where, when, is there a reason why Tom Basso is so good-natured? I mean, you sign a lot of your posts “Enjoy the ride, my friends.” It’s very good-natured. That stands out as unusual in today’s society.

TOM: Yeah, I suppose. I guess when I was going through high school, I ended up sort of observing my own behavior quite a bit. It was a weird thing where I almost had this second part of my brain that would watch what Tom Basso did every day, and I kind of – I don’t know, it was a weird thing, but it kind of gave me the ability to analyze how did I react to the world around me, day after day? I used to do it pretty much once a day, sort of think through the day and say “Did I react well to that situation? Was I overly nervous or overly excited, overly depressed, overly scared or whatever?”

I think as time went on through college and I played a lot of basketball, I started noticing being able to be sort of out of my own body. I could almost look at our defense and call out where everybody was supposed to be and could see guys behind me, because I could, in my mind, keep track of the other five guys, and there’s one missing, so he’s got to be behind my vision. Just stuff like that.

As I expanded and I got into the real world, I realized that I sort of took that attitude with life in general. It’s sort of like a movie, and I’m just flowing with it, and trading is one part of my life, but so is hitting golf balls and so is cooking dinner and so is eating dinner and so is watching television and being a husband to my wife and all the other things that go on with life. I don’t know, to make trading your whole world seems a bit shallow to me. There’s so much more to life, and it’s so short.

You get reminded of that as you get older, and I’m 61 now; you start seeing some of your friends pass away, and you start realizing, you know, it’s nice to take some time to go to Tahiti like I was telling you. I was making arrangements for it this morning. Just to enjoy some things that you’ve never done before and help other people – to me, I only have a finite time on this earth, but trading will go on hopefully way past my lifetime, and it’s nice to pass along the simple things that I’ve learned that aren’t rocket science, really, as you know from your knowledge of trend following. It’s not that difficult. People make it difficult, I think, and I think if you can help people understand how simple it is and how there’s more to life than just trading, I think that’s a good thing. More balance in the world.

MICHAEL: I’m going to give a shout-out to a young guy who I believe you’re on his podcast, Andrew Selby. I caught a line, as I was preparing to talk to you today, I caught a line where you talked about the idea of imagining – and I’m paraphrasing, so I’ll let you tell it in complete, but imagining the horror, even if it doesn’t happen, imagine feeling it. And when I saw you say that, or I saw the comment, I thought to myself, stoicism. Was I on the right path?

TOM: Yeah. I think what you’re trying to – was this a reference to how to prepare for things?

MICHAEL: Right. You’ve kind of got to go through mental exercises and whatnot, and you were talking about the imagining. My first thought when I saw it – because I always think of stoicism as like think through the worst case scenarios, live them, live them in your  mind, and then when some of these bad things happen, you’re not so surprised.

TOM: That’s exactly right, but I’d also argue that you should also live through the good times as well in your mind. When you’re getting into a position, if you can say “If this went insane, like if tomorrow or something, this stock I just bought gets an offer for twice the value that I just put into it, what does that mean? How do I react? Am I overly excited, adrenalized? Do I want to take the profit, or am I just going to follow my strategy and just do what I do?” I think you’ve got to prepare yourself for all sides of it, and not just the bad ones, but the good ones too. I think you have to think ahead, go through a lot of different scenarios, and be prepared mentally to deal with them.

MICHAEL: That’s kind of the trend following in the emotional arena as well.

TOM: Yeah, it really is. It really is.

MICHAEL: Tell me about some of – since we kind of started going down the psych side of things, so to speak, the mental side, tell me some about your mental exercises, so to speak. I’m assuming the mental exercises, whether you’re driving in the car or whatnot, that these are for far more than just trading.

TOM: Yeah. I played all sorts of games on myself over my lifetime with my brain, and I think that it reaped some good rewards. I already mentioned the observer self that I had in high school and through college. As I observe myself doing things, I think eventually somewhere, probably after college, I would say, this observer part of my brain dedicated to keeping track of what Tom was doing every day.  That sort of meshed right into my brain. It became such a natural thing for it to be there, I don’t need to think about it. I don’t see it as a separate entity or part of my brain that would dedicate itself to watching Tom do his day.

I think all sorts of exercises can – you can play games with minds, for instance. I remember Van Tharp saying that young children that were about ready – young boys, mostly, that would go out and fight their first tiger or try to hunt their first lion would be taught to defocus their eye state and see what it does to your brain, because it takes away a lot of your fear. I tried doing that on a golf course to some success, where walking down a fairway you look at a distant object, but then after focusing your eye on the distant object, like the pin, you try to see your peripheral vision clearly as well, so that the whole thing becomes this monster view going into your brain, and you’re not focused on any one thing, like that lake over to the right that your ball could go into if you hit it poorly. It’s just this one big vision, and fear goes away.

Lots of different things. Breathing, noticing that you’re breathing heavy or you’re talking faster or you’re moving faster or those types of things. Just being observant I think is a lot of it. Driving, I’ve played games with just wondering how these guys get off the drag race when the light goes green. I’ll be sitting there, and I’m watching everybody else who’s playing with their texting and listening to the radio and doing everything, and I’m sitting there in the first position at an intersection, of course being careful to look both ways, making sure nobody’s coming at me, but trying to see what would be the quickest possible reaction time that my body can take my foot off the brake and put it on the gas? Not to go fast, but just to be the first car moving into the intersection, leaving the rest of them still wondering what’s going on. Just little things like that. I think it’s all been fascinating learning how the human body works and how the brain works.

MICHAEL: I think, even though we can’t get into the minutiae of all these different types of things in this conversation, if anything, you can inspire people in the audience that are younger, maybe they’re starting out, or maybe they’ve gone the wrong direction. You can inspire people to start to think more about this mental aspect of success.

TOM: Because if you don’t have mental capability and good psychology in trading, the rest of everything you’ll do will be destroyed. You can have the most – I could automate a program, but it in a black box, hand it to somebody who is a basket case mentally, and they will screw it up, because they have the ultimate ability to – are you still there, Michael?

MICHAEL: Oh yeah, I’m here.

TOM: I heard a bleep of some sort. Must be something in the background for me. The person that doesn’t have good control of their mind is going to have a problem even executing a well-constructed black box, because they will screw it up. They will override it, they will not do a trade that they should’ve done, they’ll take profits too quick because they finally feel like they’ve got all this profit built up and they don’t wait for their stop signal to get hit. They’ll never do it.

I think as soon as people realize that the mental side of trading is the first and foremost, and then next up probably is going to be your position sizing, control of your risk, volatility, all those issues on the portfolio, and last and least important is going to be what you buy and sell, or where do you buy and sell, basically.

MICHAEL: And the emotional side, as you’re bringing that up, you’re not just necessarily pointing out to let’s say new traders or inexperienced traders. There are plenty of super successful – not necessarily sure how they got there, but plenty of super successful people, maybe they had a little luck; very wealthy people that make those mental errors that you’re talking about, and a life’s fortune can go down very fast.

TOM: It certainly does. If you look at say the first Market Wizards book and even the second one, you’ll see certain people in there that are no longer around because they might have done well up to then, but they were pushing the envelope and maybe they didn’t have their mental processes screwed on as straight as they would’ve liked and went awry along the way. I survived 28, 30 years, roughly, trading. If you want to count now, it’s another 10 years trading currencies with no issues blowing up. I’m still doing it. It’s a long run.

You’ve got a lot of traders don’t make it that long, and I think a lot of it’s due to how they think through the process and how much risk they want to take on and how much they can stay with something day after day after day after day. I’ve always been pretty calm towards the whole thing, and I think that’s reflected in – maybe – some people have accused me of being a little bit on the boring side in terms of trading; I never went for the fancy profits or anything, the big profits. But I like to try to avoid the losses and continue to plug along, and I think that serves you well over the long run. A lot of people could take a good lesson from that.

MICHAEL: Well, you’re one of my most popular guests, if not the most popular, so your “boring” must be pretty exciting to a lot of people. That’s my impression.

TOM: Yeah, every time we do one of these interviews, I get about 15 emails or Facebook letters.

MICHAEL: Let me jump into some trading issues. I had a couple points that people brought up and a couple things of my own. I saw a line, and I just want to read it to you, and tell me what you think about it. The quote was this: “if you’re not afraid of losing small amounts of money, you’re almost invincible.” How does that strike you?

TOM: It strikes me pretty well, because that would allow you to realize on things like trend following, where if you do the statistics on what we did at Trendstat back over the years, various buy/sell programs that we would have that would range from perhaps 28% reliable all the way up to maybe – the top I would ever get would be 40%, but more realistically, 36%, 37% reliable. So it’s averaging around 33%, or one-third, let’s say. That means every single trade I get into, I’ve got a two-thirds chance of losing money.

So if I take that on mentally and say okay, I want to make those two losses that I statistically know I’m going to get – I’ve got thousands of data points to tell me that I’m going to get two losses for every one gain. I might as well take the attitude that I’ve got to limit those two losses and be okay with it, because that’s just two out of the three that I’ve got to look for. For every three trades I do, I’ll get a profit; profit will be bigger than the losses. I make money over the long run. That’s what we’re doing here, so why would I be concerned over those small losses? I think once you realize that and accept it and understand why you’ve got to have those two losses, then I think you’re well on the way to making some good money.

I heard one person say one time a long time ago, trading is sort of like breathing. Everybody wants to breathe in because you get oxygen, but you have to breathe out also. That’s kind of like the losses. They’re both part of the breathing process; you’ve got to have in and out.

MICHAEL: Yeah, I tell you, as I continue my yoga practice, the breathing is the core. It’s the core of it all. Let me shift to another one. I did an interview today, and someone asked me a question, and I’m going to give it back to you. They wanted to know why trend following does so well when the black swans hit. So I was curious as to your – if somebody asked you that, “Tom, why does trend following do so well when the black swan events happen, these surprises happen?”

TOM: Trend following, by its very math, is saying, let your profits run as far as they want to run and cut your losses short when they don’t go your way. When a black swan happens, which is an outlier event of major consequence, probably, that has never happened before and has gone way beyond the realms of anything anybody’s ever seen, trend following at some point is going to pick up or move in that direction. It may be a big gap to get into it; it may have started out months ago as nothing and then all of a sudden has become a speculative bubble at this point. Every one will happen a different way, and I’ve probably seen them all in my lifetime.

But no matter where you do get in, you will get in, and you will ride part of that black swan, and that one trade and maybe a couple of others might be the difference between making money that year and losing money that year, when you take everything else and add it together. Because your small gains are going to offset some of your small losses, but to really make money, you need those real outlier events that really drive a Japanese yen position, and you’re in it for the whole year or year and a half, and the thing has gone up 100% on the face value of the currency. You’re leveraged, and you end up making hundreds or thousands of percent. That really pays the freight for a whole lot of losses, and that’s why trend following makes money.

MICHAEL: Let’s talk about your daily routine, going back a long time. I caught a post the other day on your Facebook where you were talking about the total amount of time that it took to execute your daily routine. I want you to actually talk about routines, because I have a feeling routine is very important in your life, and there’s a reason why routine is very important. But I want you to explain the time that it takes for you, but then to also interject – of course, you have to develop the system, and there’s a lot of time behind that, but then once you have your system and your daily execution – why don’t I let you run with that and explain what you had posted the other day.

TOM: Let’s talk about the two things. First, the thing on time. The other day, I posed something and I think it took me 12 minutes after the markets closed to go through my entire process. I forget exactly the numbers, but I want to say I moved four stops in the stock area times four accounts. I think I moved one or two futures trades. I can’t remember how many. I also checked and moved some stops on my hedge trades, and it all took me 12 minutes. I did that because I was getting some posts and questions from traders on how much they need to do and how often do they need to look at the market. I was getting the reaction, some of these people were spending their entire day looking at the screen. I’m thinking to myself, “What could I possibly do to waste that much time?”

I was going to try to just go ahead and time myself, just to make the point to everybody out there that sure, if you want to argue about it, I’ve got 28 years at Trendstat, another 10 years retired, honing my skills and –

MICHAEL: That’s not even 40 years yet. That’s only like 38 years.

TOM: It’s only 38 years. I’m still only 61. But when you get that much experience behind your belt, you know what you’ve got to do every day. You just have to kind of execute it. I think if you’re trying to design a new way of trading every single day and every single moment, looking at the screen and looking at the price going up and down and trying to say “What does this tell me? Should I change my strategy? Should I do some research on this new idea that I just heard in a podcast or a newsletter or wherever I got it from, a friend?” You’re going through all this gyration in your mind; that is going to just gobble up time. It’s so nonproductive.

In my case, I know exactly what I’ve got to do to execute my trend following models, and I pull up my screens and I start at the top and I start going click, click, click, click, and my mouse is – of course, I’m faster and faster over the years with my mouse and my computers, and I know exactly what I’ve got to do next, and I just keep going. I try to tell my wife, “I’m going to be closing the market down,” I tell her, and she knows to just stay away from the office for a little bit. Twelve minutes later, I was done, stopped the clock, and I went and did the Facebook post. So that’s where the time thing came from.

But routine, you mentioned, and I would say routine is important. I guess I got the routine side of things from the standpoint of the markets will wait for no one, is one of the things I’ve always told my staff at Trendstat back in the day. That’s why we had so many backups. Somebody’s taking a vacation, somebody else has to fill their spot. The markets won’t shut down because you’re having a Fourth of July, because guess what? London does not respect the U.S.’s Fourth of July. We revolted from them. So the currency markets are open on the Fourth of July. We’ve got to be there, we’ve got to still do our thing. Who’s going to take a vacation day, who’s going to work?

Routine becomes something that is driven sort of by the way the markets, and really almost life, work. Your probably get up, it’d probably be good to have breakfast in the morning, because it fuels your body for the rest of the day. It’s probably good to exercise. I see you upside-down-sideways on your yoga positions, and you’re obviously in good shape. I could not do that; wouldn’t even try. But I do work out, I am in good shape for a 61-year-old, I think, and still hitting the ball pretty well. I’m enjoying all these things.

I think that routine of exercising, routine of eating, routine of hydrating your body with water, routine of making sure you’re there for the markets. I’ve got to put my stops in and move my stops or check things once a day. On this cruise to Tahiti, for instance, that we were talking about earlier, I’m now up to a level with this cruise line where they give me unlimited internet on the concierge level, which is where I’m going to be, so I’m bringing along the computer, and sometime each day after the markets close in Tahiti, I will be on my computer for my 12 minutes. Then I will go back to having fun. But there’s a certain routine that has to be done there. I think that’s kind of the way – some people think that’s too rigid, but I can spare 12 minutes on a vacation. I don’t think of that as too burdensome.

MICHAEL: No, and especially the life freedom that you get from making the choices that you’ve made. Some people think “Oh, I’m going to go on vacation, I don’t want any distraction,” but those are the same people that go back and work a 9 to 5 grind working for the boss man their entire lives. So I agree with you completely.

TOM: Or they go back home and they find that they missed all sorts of signals that they should’ve gotten. Remembering the story I told Schwager back when he was doing “New Market Wizards” interview with me about the silver trade, that my parents were visiting me and I had missed the silver trade, and it turns out it was worth like $100,000. This was when my account was $10,000. And I had missed it, and when I missed it because I wasn’t paying attention to my stuff; I was playing tour guide to my parents – and I’m not blaming my parents; it’s my responsibility. I should’ve been doing that, should’ve been taking my 12 minutes or whatever it was back then to do my work, and I got sloppy, missed the trade, missed that profit. That would’ve put me way ahead of where I ended up being now. I would’ve been that much farther ahead at an earlier stage and been profitable more early in my trading.

So you have to really look at how you go through every day and ask yourself, where does the time slip away? Because you wake up in the morning, you go to sleep at night, and there’s a lot of minutes in between, and if you really think about what you spend them on, it’s kind of amazing how many you can waste.

MICHAEL: In this day and age, we waste a lot more with all these electronic gadgets, for sure.

TOM: Absolutely.

MICHAEL: This is a question from Fred Penny, and Fred had – I thought it was a good question. He said if you were a 20-something guy or gal today and not much money and you’re just getting new knowledge, if you were looking back with your experience and saying today – and you were approaching the trading world today, would you approach things the same way? Would you go about it the same way?

TOM: I don’t think so. I ended up, of course, as most people know, a money manager, a futures trader, and a currency trader, and Trendstat Capital was my firm before we shut it down back in 2003. Back in the day when I started, which would be back in – I was starting to trade in the ’70s and really got our first firm off the ground in 1980, formed Trendstat in ’84, broke away from the previous firm, Kennedy Capital, and ended up at Trendstat.

When I did all these things, track record – if you could just establish that you were trading even $100,000 and doing it successfully over a period of say one, two, three years, and maybe showed growth and assets from $100,000 maybe to a half a million – maybe you’ve got a million now under management – people would take a serious look at you and say “This guy’s making progress, his track record looks solid, I like his approach, he seems sensible. He seems like a smart businessman. He’s hiring people to back him up. He’s got computer equipment. Yeah, we’ll give him a chance. Here’s another $5 million,” and now all of a sudden you’ve got $10 million under management, and all of a sudden somebody will give you another $10 million and pretty soon you’re at $20, and then you’re off to the races and you can build your business that way.

Nowadays, I get the perception – and I’m a little bit removed from the industry these days, being retired, but I’ve heard stories where some asset allocators would want you to have $20 or $50 million under management and have a staff of 10 people and computer equipment and backup locations and marketing staff and everything else. I don’t know how I would’ve ever gotten into the business back in the day. So I think in today’s world, with all the automation and with all the – basically, I use Schwab and Interactive Brokers for the two sides of my trading in a lot of my stuff, and I use them all around the world. I’m in Italy or Tahiti or anyplace, I get an internet connection, and boom, I’m in. No big deal. A lot of the charting software and all that stuff, we had to build that at Trendstat in the old days. Nowadays, it’s free with your account, and it just keeps getting more and more sophisticated.

I’d be inclined to go ahead and work, as you said before, a 9 to 5 job of some sort, and perhaps one that had a little bit of flexibility to it so that I could do some trading as I was working the job. When I was a chemical engineer, I could easily go home at 4:30 from designing chemical plants and spend a half an hour working on my commodity account and transmit my orders and then go have dinner. It wasn’t a big deal.

MICHAEL: So your real issue, if I’m hearing you, is it’s the money management versus the trading, and they’re not one and the same.

TOM: No, they are not. And for those people who think they’re going to get in the money management industry, let me tell you that the year before I shut Trendstat down, I spent $100 grand on regulatory CPA and legal fees at no benefit to my client that I could see, and I spent probably 60% of my time either with personnel, accounting, or legal issues, and less than 10% of my time probably actually doing meaningful research or trading that most people would think is the fun thing that they like to do. You spend very little time trading, more time running a business if you want to be successful at it.

I think for most people, if they love trading, I would suggest staying a little longer. If it was me right now, I probably would’ve stayed an engineer or moved into the business side of my company that I was at. I probably would’ve done a little more strategic planning and business things and tried to get – I was highly rated at this company I was at; I was promoted a month before I quit. They seemed to like what I was giving them and doing. I would just get more raises there, get into stock options, get into whatever you can get into, and keep saving a lot of that money. Put it into your trading accounts. Hone your skills at smaller amounts of money and then get your portfolio to the point where it was supplying an extra source of income for you.

And when that extra source of income got to the point where it was equal to your current source of income, you probably could safely retire at that point, and I probably would guess that, rather than retiring at 51 had I done that, I might’ve been able to retire even before, because the things that I did at Trendstat kind of, by their nature, had to be very regulatory. For instance, I couldn’t front run or do anything. I had to be careful with what positions I have versus the clients and all these things. So basically, I had to keep everything pretty plain vanilla with my own trading, sort of to match my clients. Or I actually put my money in the same fund that my clients are in so that I’m getting exactly the same trades, in essence, so that there would be no favoritism to me or the clients, because that’s illegal.

I think without those restrictions, what I’m finding after 10 years of retirement is I can do things that I could never do for clients. I trade orange juice futures. Jeez, I only need one of them or two of them for my portfolio. If I had Trendstat with $600 million under management, how am I going to buy orange juice futures? I might be able to buy 10 or 20 of them, but that’s not going to mean anything to my clients, so it’s a whole different world when you’re trading for yourself.

MICHAEL: Yeah, you mentioned a regulatory environment, and I think it’s worth pointing out that – and I’m not purporting to be a regulatory expert, and I’m also not taking a shot at our home country, but it probably is worth investigating, for those folks listening, that not all regulatory climates are the same and not all home countries are the same, so there might be some situations that are a little less strident than others. And I’m not saying that in a way that they’re less strident, that that means it’s cowboy and no regulation. I’m just saying that there are some places where it’s gotten a little tougher than others.

TOM: Yeah, and there’s some places that are easier; some places that are actually worse than the U.S., probably, in some ways. Very, very ancient thinking on certain things. And some states in the U.S. that are worse than other states. Wisconsin comes to mind as a state that seems to have extremely stringent restrictions on mutual funds and things like that. They seem to always have a tough time getting people to blue sky their stuff.

MICHAEL: Worth investigating, though, for those folks listening. Don’t make assumptions that everything and all climates are the same and all countries are the same.

TOM: And sadly, some of the trends I have on Facebook that are foreign-based – they’re in Australia or they’re in Vietnam or someplace – they realize, as I did, that a lot of the assets that you can obtain to manage seem to be in the U.S.. We are a very wealthy country, and there are a lot of assets, a lot of pension plans and things that need to be managed. When I got in the currency business, it got a little bit better because there was less regulation on currency trading and there was banks like Royal Bank of Canada, Bank of Montreal, Soc Gen over in France, other places that I had as clients where I didn’t have the regulation and they weren’t in the U.S. and having to deal with U.S. stuff either.

So I had some U.S. banks as clients, I had some foreign banks as clients. It was kind of an interesting mix. Different environments are definitely to be explored, because how you run a business is all going to be about what you’re allowed to do, because between the government and your clients restricting the money manager and what he or she is able to do day to day managing the portfolio is going to dictate some of your success. If your clients and regulation don’t let you buy orange juice futures, then it can’t be part of your portfolio. It’s just a simple fact. So that does affect your returns. You have to think about that.

MICHAEL: Let me shift gears on you. I love shifting gears on you. Why not, right?

TOM: Yeah, why not? I love it. That’s why I like your interviews. I never know where they’re going.

MICHAEL: Yeah, my brain’s not a straight line. So Clint Stephens – I think you know Clint.

TOM: Yeah, I know Clint.

MICHAEL: It’s kind of a combination question here, but he wanted to know, do you tinker with your current systems, and kind of adding into that, how do you know when you’re dealing with a normal drawdown versus like “Uh oh, this system is shot”? Do you still tinker, and how do you know when something has really gone the wrong way?

TOM: Okay, first one, do I tinker? I’m currently, in my futures trading, using the same buy and sell triggers that I think I created and probably was using back in about 1984.

MICHAEL: How ancient. How archaic. They can’t be useful. They can’t be good anymore, Tom. They’ve got to be – retire those.

TOM: No, they’re virtually identical. I used to sit down, and the only difference is I used to do it all on graph paper, and now I have computers that are sitting there, and I’m looking at fancy colors and all sorts of data that I didn’t have available, so it’s a little easier.

MICHAEL: So the graph paper would take you from 12 minutes to 30 minutes?

TOM: Oh yeah, I used to take about an hour doing my futures portfolio. My goal over my lifetime was actually to put myself out of work so that I could have more time to golf and do other things.

MICHAEL: So you don’t tinker. Okay, that one’s off.

TOM: No, but that being said, let’s say I come up with – well, for a good example, ETFs never were around; back in the day, I traded mutual funds, so we’d look for no load mutual funds, and we’d have to do end of day buy and sell, because that’s the nature of a mutual fund. When ETFs, exchange traded funds, that is, came into being and started trading continuously throughout the day, then you could start thinking about stuff like stop orders and you could do things that might get executed intraday; even if you were not executing them, the stops would be executed intraday. To me, it minimized the risk of the overnight gap type of situation a little bit more and therefore was a good thing to start looking to add to my portfolio.

I wouldn’t call that necessarily tweaking as much as looking at various new products that might come into the portfolio, and I might have to do something a little different to actually try to physically trade those, but the ones that I’ve had in the past, I don’t tweak too much, no. And on the other question you had, on –

MICHAEL: If the drawdown starts to be a little steep, how do you know when things are…

TOM: I’ll tell you what I do there, and this is the scenario analysis we were talking about earlier a little bit: if you know you’ve got a strategy and you’ve thought through “Okay, if this thing goes well and I have these types of market conditions, this is what’s going to happen, good; this is what’s going to happen if it goes really to crap; and this is what’s going to happen if we just kind of have an expected month or six months.”

If you’ve really thought and done a good job of that, then you should ask yourself on a drawdown, look at the markets you’re trading, look at your portfolio, look at the market action that has been provided to you by the market – you had nothing to do with that; that was just the universe sending you ups and downs and all over the places – and ask yourself, given those conditions, would you have expected anything different than what you’re seeing? If the answer is yes, then I would say then something’s wrong with your strategy and you need to do some tweaking, you need to do some homework and work and research and whatever to find out what’s the difference between what you would’ve expected versus what actually happened.

But if you answer that same question, “This is an extraordinarily choppy period, and there’s been some violent disruptions that I would get caught in with this strategy, and I would expect to have a drawdown,” then it’s not broken; don’t fix it.

MICHAEL: Straightforward. Straightforward.

TOM: That’s kind of how I look at it.

MICHAEL: Jim Byers has a question, and Jim was curious if you are a one system guy or multiple systems?

TOM: Multiple. When we were at Trendstat and running our flagship fund. The Market Math last year before I closed everything down, we had six different portfolios within the fund that ranged from trading commodity options to two different approaches in currencies, two different approaches in futures, and one approach to mutual fund timing. I think within the mutual fund timing, even, there was two different sub-pieces to that, and in one of the futures areas, there’s probably a couple sub-pieces there. So there was a lot of interesting stuff going on there, and all those maths were trend following, in a way, but they were all very different in how they took on what they on.

MICHAEL: So they ultimately all got to trend following, but you had fought through different ways of getting there.

TOM: Mm-hm. Based on the markets, based on what I was trying to accomplish, based on how much risk that particular portfolio was trying to take on. Some of the strategies we had, particularly the ones that were more 28% reliable, because they’re 28% reliable, the math would say you’ve got to have a bigger gain when you have a gain, and the losses could be bigger as well, but you’ve got more losses that you’re going to take as a percentage of the total. So you’ve got to have a real big one hit. So that was one where we slightly added to positions in a conservative way when risk would allow, and we would try to really maximize those particular trades each year that came along that really, really paved the way.

Other strategies were more “Just catch every intermediate move up and down and don’t worry about the big one; we’ll be there for it. If we get whipsawed along the way, so what? The big guy next door will pick up the big gain and not get whipsawed.” So we’d have different personalities to these trading strategies. Some clients would pick and choose and say “I like that, I don’t like that”. Or if you got Market Math, then it was my decision as to how it was all allocated. We did a lot of research on that and how much exposure we wanted to each of the strategies, and then we rebalanced that monthly back to the set point so that – kind of the Robin Hood approach of taking from the wealthy strategy and giving it to the poor strategy. So whatever was in a drawdown was being fed; whatever was on an explosive up move and equity was coming in like crazy, we’re taking money off of the table. That stabilized everything and kept us with a nice steady performance.

MICHAEL: I think you’ve got some great wisdom and you’ve got some great perspective, and you’ve had a very long business career, starting as a young man. We’re in an interesting climate, so to speak, an interesting economic climate, and everybody can hear the political debates. Regardless of the side of the fence you’re on, the debates are out there. Some folks want more government, some folks want less government. I know where you fall on the spectrum; we probably have very, very similar views.

I’m not really looking to go down the blame game or the names game, but I would really just like for you maybe to paint a picture, from your perspective, watching markets evolve, watching governments evolve, and especially watching the Fed’s involvement, maybe paint a case for people that don’t have your time horizon lens. Paint a picture for people about how you see what’s going on today in terms of – let’s just keep it very narrow – Fed action. It seems like to me we’re in brave new territory. Are we, or is it just some of the same that we’ve seen over the decades?

TOM: Well, I might back up from just the Fed thing to even a little bit something just slightly bigger than that in that society in general these days seems to be gravitating down, and certainly Fed is doing the same thing along this line of not taking responsibility for themselves. It’s really – you’ve taken the responsibility, for instance, to go to Vietnam, to go to Asia and to do your speaking, to bootstrap a business out of your podcasts and to be successful.

I think that took a lot of work and a lot of courage and a lot of things, and I think the average person, when they’re in front of the television every night and they can get a government stipend of some sort or maybe can get an unemployment benefit and not have to go out and look for a job tomorrow, or “It’s kind of cold tomorrow; I think I’ll stay in” – I think suddenly, second by second, minute by minute, and with respect to the Fed, the same thing, there’s this tendency to think that government, the Fed, and the big entities are going to take care of all these little individuals.

And the individuals kind of allow them to do that, strangely, because it’s the easy way to go rather than the difficult way that you’ve gone or that I’ve gone. It’s easy to not take responsibilities, easy to say “Somebody else is to fault for the way that my little life is today.” I think the Fed is sitting there saying, okay, well, we’ve got an economy that’s being overburdened by a government that’s spending more than it takes in; we’ve got $17 trillion in actual debt, we’ve got $100 trillion in unfunded liabilities. That adds up to about $117 trillion. The GDP of the country is only about $15, $16 trillion a year, so that’s multiple years of total 100% GDP to even get close to this huge number of liability that we have. That’s not a good recipe for success, I don’t care – I can’t imagine how any economist could put a good spin on that, although the Keynesian seem to try.

But the reality of it is, Fed is just saying “What other choice do we have?” If the stock market were to crash, if commodities start skyrocketing, if we have unabated inflation or if we have a depression or whatever, it’s going to spill over to the entire world. It could get really rough, and then there’s going to be riots in the streets and there’s going to be all sorts of problems. And I hate to be negative, so you try to look at the positive side in that and you try to say “Okay, let’s see if we can keep funding enough money into this thing to keep it muddling along somehow.”

Over time, maybe somebody brilliantly figures a way out of a mess, but it’s looking pretty dismal, I think, over the long run in that I don’t think the Fed – the Fed has used so many different tools so far, and I think they’re running out of their arrows in the quiver, so to speak. They’ve kind of used them, and I don’t know what they’re going to be able to do going forward if things get tough, so I would remain very cautious towards your trading, and I would also look, like you have, at other countries and diversify internationally if you can. Do what you can to protect yourself, because I think times could get a little interesting going forward.

MICHAEL: I think what’s interesting about what you say, too, is – I saved that question for last because I wanted to establish in our conversation that you’re a price-based trend follower and that your trading is going to respond to whatever activity is happening in the markets, either up or down. To place the view that you just had, the public policy view that you just put out there, that’s just your learned view about the proper way society should go, but your trading is going to – you’re going to do well whichever way the markets go.

I think sometimes people get a little lost in that. They might say “Why does Tom Basso have this opinion?” or “Why does Mike Covel have this opinion about the markets? Who cares?” It’s gotten so unusual, if you don’t have a public policy view, regardless of what your trading is, I start to wonder what’s wrong with you. Not you, Tom, but this has gotten so unusual out there that if you don’t have a view, it kind of scares me.

TOM: And it also goes back to what I think I did in the Andrew interview that you probably listened to about one of the most profound things that happened to me along the way was this ability to listen to someone talking and separate fact from opinion and flag them in my brain. So when you’re reading a Wall Street Journal article that some panelist is saying “I think this, and the market’s going to be here, and that’s my prediction,” you just flag it and say “Okay, that’s interesting, but it’s just an opinion.” And when Tom says something or Michael says something, the same thing.

However, if I say “the market closed at 183.76 today,” or whatever number it is, that is an actual data point. That’s a fact. That’s not my opinion; it is just a number. I think once you start separating facts and data from people’s opinions, the whole world of trading gets a whole lot clearer, because in my mind, I could think the world’s going to come to end, go to hell in the next year, and I could still be long in the market. I really don’t have any other choice. I mean, where else are you going to put your money and where else are you going to try to hold onto some value with the Fed devaluating the dollar by pumping so much money into the system? You’re probably going to end up having to make 10% and 20% returns just to try to even hold yourself even in terms of purchasing power, and that’s a pretty daunting task.

MICHAEL: Yeah, it is strange days indeed. But I love hearing your wisdom, and I know the audience does, too, and I appreciate you taking the time today from Arizona.

TOM: Lovely Arizona. Sunny and 68 today.

MICHAEL: I’m jealous. It was like 5 degrees here the other day. Hey, Tom, listen, people, if they want to catch up with you, they’ll have to find you on Facebook. You’re not trying to advertise anything or promote anything, I know that.

TOM: No, I’m retired happily. I’m not advertising anything.

MICHAEL: If they can find you, that’s the challenge. If you want to find Tom, you have to find him. I’m not telling you where he is.

TOM: If you can spell “T-o-m,” I think…

MICHAEL: They’ll find you.

TOM: Yeah.

MICHAEL: Hey, listen, Tom, I appreciate it, and hopefully we can talk again in the new year, once I’m in another continent.

TOM: No problem, Michael. Enjoyed it. You’re welcome, as usual.

MICHAEL: Thank you, sir.

TOM: Bye.

MICHAEL: Take care.

If you want to learn how to be a trend-following trader, the first place to go is trendfollowing.com. My firm can help you with educational, research, and systems trading packages to get you started immediately. Take advantage of my 15 years of experience. Take advantage of all the insights that I’ve accumulated and put into one research and educational package. These are systems that you can use immediately to start making money. Once again, go to trendfollowing.com.


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6 thoughts on “Ep. 200: Tom Basso Interview #3 with Michael Covel on Trend Following Radio

  1. Well done Mike. Another great interview with Basso. Loved his cool response re: whether a draw down is just the usual or the system is broken. Cool as.

  2. It’s very frustrating that I can not download the Podcast directly from the website. Great interview with Tom Basso Mike.

  3. I absolutely agree with Tom’s reflection on how he would do things differently today. The financial industry is the most regulated industry in the world. As a result, all the “sheep” out there have zero chance of having their money managed by the best in the business because lawmakers have deemed such investments as risky based on generalizations and flawed analysis. Their “protection” of the masses has guarantees that these sheep will be herded into the mutual fund/big bank pens to get their usual sub-par returns with oversized fees.

    I originally dreamed of starting a hedge fund, but soon came to realize that — as Tom says — most of my time would be spent on non-trading activities. Consequently I trade only my own money. With the ability to focus and constantly improve, I have been fortunate enough to have results that beat anything I have seen, published or private.

    I have no desire to manage other people’s money. I went into trading for freedom — Why would I give that up to answer to a bunch of suited, moronic institutionals who don’t understand simple concepts like volatility, real returns, and the essentials of risk management?


  4. BTW, Michael,

    I should mention that my returns became exceptional only AFTER I read Trendfollowing. Until then I was doing the usual research, following analysts, etc. TF taught me about the world of algorithmic trading and I haven’t looked back since.


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