Although Richard Donchian passed away many years ago, his influence resonates. He is known as the father of trend following. His original technical trading system became the foundation on which later trend followers would build their systems. Where do you think the Turtle system evolved from? He is noteworthy among traders in general, as he was the originator of the managed money industry. From the time he started the industry’s first managed fund in 1949, until his death, he shared his research and served as a teacher and mentor to numerous present-day trend followers.
Donchian was born in 1905 in Hartford, Connecticut. He graduated from Yale in 1928 with a BA in economics. He was so fascinated by trading that even after losing his investments in the 1929 stock market crash, he returned to work on Wall Street. In 1930, he managed to borrow some capital to trade shares in Auburn Auto, what William Baldwin in his article on Donchian called, the Apple Computer of its day. The moment after he made several thousand dollars on the trade, he became a market technician, charting prices and formulating buy and sell strategies without concern for an investments basic value (source: William Baldwin, Rugs to Riches (Section: The Money Men), Forbes (March 1, 1982)).
From 1933 to 1935, Donchian wrote a technical market letter for Hemphill, Noyes & Co. He stopped his financial career to serve as an Air Force statistical control officer in World War II, but returned to Wall Street after the war and he became a market letter writer for Shearson Hamill & Company. He began to keep detailed, technical records on futures prices, recording daily price data in a ledger book.
Barbara Dixon, one of his students, observed how he computed his moving averages, posted his own charts by hand, and developed his market signals without the benefit of an accurate database, software, or any computing capability. His jacket pockets were always loaded down with pencils and a pencil sharpener (source: Barbara Dixon, Richard Donchian: Managed Futures Innovator and Mentor. Futures Industry Association). Much of Donchians work went unnoticed by the numerous stars of finance that followed him. Dixon makes it clear that her mentors work preceded and prefigured that of the academic theorists who developed the foundations of the modern theory of finance.
Long before Harvard’s John Litner published his quantitative analysis of the benefits of including managed futures in a portfolio with stocks and bonds, Donchian used concepts like diversification and risk control, key elements of modern portfolio theory that won William Sharpe and Harry Markowitz Nobel prizes in economics in 1990 (source: Barbara Dixon, Richard Donchian: Managed Futures Innovator and Mentor. Futures Industry Association).
Donchian’s original methods involved the use of a moving average for the entry/exit indicator portion of his system. Money management accounts for 90% of trading success. Then once you have that down, your psychology accounts for 100% of your success.
Mr. Donchian was best known for his pioneer work in the field of commodity futures money management. He was a member of the Commodity Exchange, Inc., the New York Cotton Exchange, the New York Futures Exchange, the New York Society of Security Analysts, the American Statistical Association, the National Association of Future Trading Advisers, the Financial Forum, and listed in Who’s Who in America. In June 1983 “Managed Accounts Report” selected him as the first recipient of its “Most Valuable Performer Award,” for outstanding contributions to the field of commodity money management (source: source: http://www.rddonchian.org).
Donchian: The Personification of Persistence
Was Donchian an overnight sensation? After 42 years, Donchian was still managing only $200,000, despite his detailed graphs of price charts for stocks and commodities. Then, in his mid- 60s, everything came together, and a decade later, he was managing $27 million at Shearson American Express making $1 million a year in fees and commissions and another million in trading profits on his own money (source: William Baldwin, Rugs to Riches (Section: The Money Men), Forbes (March 1, 1982). Mid-60s? What patience and persistence!
Like all of the other great trend followers, the importance of price was critical for Donchian. This excerpt from William Baldwin from a March, 1982 edition of Forbes says much:
He didn’t predict price movements, he just followed them. His explanation for his success was simple and as old as the “Dow Theory” itself: “Trends persist.” “A lot of people say things like: Gold has got to come down. It went up too fast. That’s why 85 percent of commodities investors lose money,” he says. He was never distracted from his system. “The fundamentals are supposed to be bullish in copper,” he says. “But I’m on the short side now because the trend is down.”
What were his rules? The following Donchian trading guidelines were first published in 1934:
General Guidelines from Donchian
- Beware of acting immediately on a widespread public opinion. Even if correct, it will usually delay the move.
- From a period of dullness and inactivity, watch for and prepare to follow a move in the direction in which volume increases.
- Limit losses and ride profits, irrespective of all other rules.
- Light commitments are advisable when market position is not certain. Clearly defined moves are signaled frequently enough to make life interesting and concentration on these moves will prevent unprofitable whip-sawing.
- Seldom take a position in the direction of an immediately preceding three-day move. Wait for a one-day reversal.
- Judicious use of stop orders is a valuable aid to profitable trading. Stops may be used to protect profits, to limit losses, and from certain formations such as triangular foci to take positions. Stop orders are apt to be more valuable and less treacherous if used in proper relation to the chart formation.
- In a market in which upswings are likely to equal or exceed downswings, heavier position should be taken for the upswings for percentage reasons a decline from 50 to 25 will net only 50 percent profit, whereas an advance from 25 to 50 will net 100 percent profit.
- In taking a position, price orders are allowable. In closing a position, use market orders.
- Buy strong-acting, strong-background commodities and sell weak ones, subject to all other rules.
- Moves in which rails lead or participate strongly are usually more worth following than moves in which rails lag.
- A study of the capitalization of a company, the degree of activity of an issue, and whether an issue is a lethargic truck horse or a spirited race horse is fully as important as a study of statistical reports.
Trading Never Changes
Today, most people fixate on the new and fresh fast money idea of the day, yet I still find almost every word Donchian (or Dixon) wrote newer, fresher, and more honest than anything currently broadcast on CNBC. My favorite Donchian wisdom tackles an issue that people are still struggling with in 2009:
“It doesn’t matter if you’re trading stocks or soybeans. Trading is trading, and the name of the game is increasing your wealth. A traders job description is stunningly simple: Don’t lose money. This is of utmost importance to new traders, who are often told do your research. This is good advice, but should be considered carefully. Research alone wont ensure a profit, and at the end of the day, your main goal should be to make money, not to get an A in How to Read a Balance Sheet.”
Donchian’s blunt talk may explain why Harvard’s finance curriculum does not include mention of Dunn, Henry, Seykota, Campbell, Parker, Abraham, or Donchian himself.
- Donchian’s account dropped below zero following the 1929 stock market crash.
- He was one of the Pentagon whiz kids in World War II.
- He served as a cryptanalyst and worked closely with Robert McNamara during his Air Force tenure.
- Donchian did not start his trend following fund until age 65.
- He traded into his 90s.
- He personally trained legions in the art of trend following.
- He trained women at a time when women had little respect on Wall Street.
Donchian and his Students
Richard Donchian, though now deceased, left many students that still trade or run money management firms. A sampling of his students include: Nelson Chang, Robert Crowell, Barbara Dixon, Bruce Terry, Paul Dean and Brent Elam.
What’s the point? Trading as a trend follower is a learned behavior. Not everyone is going to trade this way. Most people want no more complexity in their life than to buy and hope. Most people don’t want to think or learn about new methods. It takes discipline.
But, if the students of Richard Dennis or the students of Richard Donchian don’t provide inspiration as to how important learning the right method is toward achieving success…well buy a mutual fund and shoot for 5% a year.
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