Cesar Alvarez Interview –

www.bettersystemtrader.com

Cesar Alvarez Interview

Better System Trader – Session 003

Andrew: Thanks a lot for joining us today Cesar.

Cesar: Yeah, I’m glad to be here.

Andrew: Perhaps if you could start by giving us a little bit of the background of how you got into
trading and how you got up to where you are today.

Cesar: Sure. The way I got in trading was back in 1996 when I first started getting interested in
trading. At that time I just recently left Microsoft. I had a small nest egg to be investing
and I probably followed the traditional path that most people did. I started off by investing
in mutual funds just trying to understand things, trying to be safe. For mutual funds,
probably 1997 or so within a year I started getting more into stocks, felt I learned enough
about stocks. I started trading stocks at that point – doing it big, O’Neill was big at that
time frame, of course I was following O’Neill.

Got to enjoy The Heady Fun; 97, 98, 99 years I had some amazing years trading stocks
there and at that time I confused a bull market with brains and even though I may have
had good years, it was purely because I was in that strong bull market and got hurt in
2000 like a lot of people did fortunately not too bad. And around then I started… I picked
up Amibroker and I started getting into my quantified kind of stage where I started
learning about programming, testing ideas and that’s how I started finding out a lot of
ideas out there just did not test out when I tested them, I was really quite surprised.

Also around that time I got to a site called tradingmarkets.com. Run by Larry Connors and
he had lots of good strategies there, he quantified his stuff, I tested his ideas, they worked
pretty well and I definitely started getting more interested in him and his work. In 2004
after two years of trying I finally got my job working for Larry Connors in Connors research
and really dove head-in into the whole quantified, quantifying all these strategies into
mean reversions, see what works and doesn’t work. I spent nine years working with Larry
and during that time I really got my own trading personality down in the sense of really
being a short-term mean reversion trader but that was all we, not all but that was the

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majority of our research and that’s where most of the successful strategies that we
discovered were and that is what hit my personality really, really well.

And then in 2013 I left Connors research to come out on my own. I wanted to do my own
blog, start my own trading service and that’s where in a sense my whole history is and
now I am primarily a stock trader in mean reversion. I do both, a little bit of rotation, a
little bit of monthly holding too. I dabble in options, I think there is great potential
opportunities in options I just haven’t found anything that works unfortunately – every
time I dabble in options I have a negative impact on my account I have to say but I always
do it with small amounts and I think there is something there eventually I will find so it is
kind of a quick overview of my trading history and where I am now.

Andrew: So can you give me a brief overview of your current business?

Cesar: Sure. Right now I do several things. I run the quantified research blog Alvarez Quant
Trading on that site. I usually publish a couple of articles a month on research I’ve done,
mostly on stocks and ETFs. I am also an Amibroker consultant where I do testing of trading
ideas for others so I also have Amibroker education video class that I’ve got for people to
buy and also I’ve got the training single service called TranquilityTrading.com where I
currently have S&P 500 rotation strategy and a leveraged ETF strategy and I’m looking to
add a couple more strategies by the end of the year so those are my main businesses that
I’m in right now.

Andrew: Wow, that sounds like you’re very busy.

Cesar: Yes it does keep me busy but very enjoyable.

Andrew: Okay thanks. So your days at Connors research, you published a lot of different strategies
and research, obviously you tested a lot more than that. Where did you come up with
ideas back then?

Cesar: But then while working with Connors research I would say 90% of the time Larry Connors
would come up with what I call the original idea – you plant the seed. And we actually a
really good team because he was really, really good at coming up with good ideas. That is
something I will honestly say, I am not great at coming up with brand new unique ideas
but where my skill really shines is taking an idea and making it really good. He would come
up with ideas and I would improve on them significantly and convert them into something
worthwhile trading or worthwhile to share to our subscribers or anything like that.

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Nowadays where I get most of my ideas is I do a lot of reading of blog posts, that’s where
I get my ideas and where I find something. I would see an idea and test it out and if it
looks like it has potential I would make it good by adding my own ideas, my own trading
style to it.

Andrew: Right you actually post a lot of research on your blog and you get a lot of responses with
ideas from other people on things to try. How do you keep track of all those ideas?

Cesar: I have to say when people ask me this question is I have a page that I keep on my computer
with trading ideas with things I eventually want to research. That page grows at a much
faster rate than I could ever tackle it. I am just always, I mean if I bring that page up and
probably could say I have 100 ideas on there to test. The next obvious question is – what
do I decide to test? And it is usually something just catches my eye and I will decide to
test it.

Recently what’s caught my eye is dual momentum, a very popular ETF topic on the
internet this year. So I definitely have been doing a lot of research in it recently for my
own trading. But again I get it everywhere, I just a huge list of stuff that I could… I could
stop taking ideas and spend the next several years just whittling down that list but I’m
always chasing the latest, greatest ideas too.

Andrew: Right. So when you’re testing ideas, you must have some type of expectation on how it’s
going to work. What do you find after you’ve tested things?

Cesar: Yes, you’re right. Normally I have an expectation of whether it’s going to work or not. But
I had a running joke with Larry Connors. He would ask me that she would send me
something to test and he goes, “Well, do you think it is going to work or not?” I’d give him
my answer I say, “Yeah I think it’s going to work.” But then my response back was, “Yeah,
half the time I’m right, half the time I am wrong and that is why we test.”

Sometimes the things that I just think will fail miserably surprised me and actually work
or work well. Things that I just think, “This will make money, this will just print money,”
fail miserably. So even though I may have expectations going in, that is why often I will
write blog posts. I would post something up that doesn’t work. People sometimes think
that you just come up with an idea that works or just because I have been doing this for
10+ years or whatever every idea that I come up with works and it doesn’t work that way.
Sometimes there is no rhyme or reason of why something works or doesn’t work.

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Of course, if someone gives me a mean reversion strategy and I can look at the rules I can
tell you pretty quickly how well it will work or won't work just because I have done so
many mean reversion strategies. But if it is something different, if it is a new twist on
something, sometimes you just don’t know and it is really that simple you think, “I’ve got
to test it.” That’s why I do the blog, it keeps me testing and sharing with people.

Andrew: Okay so you have been testing for a lot of years now so you must have a good
understanding of some of the challenges with back testing. Can you explain a few of those
that you have seen in the past?

Cesar: I have a great post on this called, “Back testing is hard.” And this is one of the things I
really enjoy about this line of work is you may think you have found something great but
the pitfalls are… there is just so much potential pitfalls. They fall into just the general
category of data. People will be surprised if they knew how dirty their data is. I think
people think that the data is pristine if they are getting it off of Yahoo or some other major
data provider that it’s good and it is non-changing and it is fine; there is a lot of problems
with the data out there.

Yeah, I’ve looked at some of the major data providers and I have compared them against
each other and sometimes there is pretty big differences. And you can’t really point and
say half the time who is wrong and who is right. So data is one of those things I have
always been concerned about, that is one major pitfall.

Another pitfall that is common for people it is the usual pitfall, data mining – over
optimizing systems trying so many different variables or trying so many different
permutations or just or you have just you have done 1000 permutations which is not that
big of a deal but then only focusing on the one that did the best and not kind of focusing
on maybe the top ones and see how it does in general, that’s another general pitfall.

And then there’s just the basic programming. It’s really easy to access a look into the
future or think you’re doing things one way and you are not. I mean recently, was it earlier
this year it was? I have been trading a system about three months or so until I realized
that the ranking I was doing was off by a day so it was not… So it was not exactly perfect
in the way of code. Lucky for me it did not have a significant impact on the results but it
was not correct and things like that. I mean you may have things that look correct, feel
correct and are just suddenly wrong and the results aren’t what you expect and it can be
really bad especially if you’re doing something that is impossible in a sense, you’re looking

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into the future then your test results are definitely nowhere near correct. So those tend
to be the three major areas that I find can be problematic for most people.

For myself at this point it is mostly making coding errors and not catching them. It is
always my biggest fear is making a coding error on a blog post and I have got to retract
the entire blog post because I did something insanely stupid, But it doesn’t have to be
stupid, just something suddenly wrong that it is hard to catch.

Andrew: Right so what steps do you personally take to avoid those type of mistakes in the back
testing process?

Cesar: Unfortunately I can’t do the steps I used to do with Connors research. But the way we
used to do it with Connors research is Larry would send me an idea, I would test it, refine
it and I would finally get something I think, “Oh, this is a great strategy. We want to trade
this,” or, “We want to sell it.” What then I would do is I would give the English rules to
one of our other researchers and then they would have to duplicate our results so they
would take… I would tell them, “Okay here is the English rules,” I wouldn’t give them any
formulas and they would go off and try to duplicate our results and it seems that was our
best way of verifying that there is no mistakes in our code in the sense of…

Granted, it is not perfect because if you both make the same assumption and it is a wrong
assumption you could get a mistake in there; it happened once for us and fortunately it
was very, very minor mistake but I and the other coder made an assumption about
something that wasn’t a very good assumption and it was a mistake there.

How do I do it now? I just look over trades. You just look over the trades making sure
everything looks right. It is painful – you look at 10, 20 trades and say, “Okay, does this
look right?” Fortunately after doing it for a while I tend to know where the errors are and
where I tend to make the silly mistakes but that is the biggest fear I always have is making
a mistake and it is hard as an individual to catch the subtle mistakes. It is easy to catch
the big mistake of, “Oops, I am getting it out at the close, I should be getting out in the
open,” things like that can be really easy to catch or, “Oops, my stop is not working.”
Things like that. Those tend to be the easier ones.

The subtle ones are, “Oh I am supposed to be ranking off of today’s close but I am using
yesterday’s close,” things like that can be really subtle and really hard to catch. Well the
really hard things is when you are missing trades that you should be getting and it is hard
to know, those kind of things are really hard to find and it is just walking through your
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code and looking at it. And that is why I have a say on stuff I saying on the Internet and
even my own stuff is “trust it but verify it.” Nobody out there is publishing stuff that is
purposely wring but they are human, I am human we can all make a mistake and that is
why when you see something out there that looks really good just don’t go trade it. Try
to verify the results. It is not that you don’t trust them but they could have made a
mistake. Heck, even my research, don’t trade off what I’ve published, make sure you try
to verify it for yourself to say – yeah, make sure I didn’t make a mistake.

Andrew: Okay so one of the challenges of back testing you mentioned was over-optimization. How
do you know that you have over-optimized a strategy?

Cesar: That’s the million-dollar question. I like to say a lot of people are trying to break up a lot
of things in backtesting into black and white by saying, “You must do things this way,” or,
“If you do it this way you have over-optimized.” Unfortunately to me it is a lot of gray
area. And this definitely falls into one of those gray areas. One person’s over-optimized
strategy is another person’s “It looks fine to me you are not over-optimized it.”

I remember about a year ago early on I started the blog I got into an off-line discussion
with a guy who basically thought the fact that I had three different variables means I have
over-optimized it which I disagreed with him but that is perfectly fine. I told him, “Look,
that’s great. That’s what you believe, great; build your strategies that way.”

Yeah if you take a strategy, make 5 million different combinations of it, got 20 different
variables, yeah, most people will agree that you over-optimized it but then you have a
huge gray area of, “Okay you’ve got only five variables and maybe you run 1000 or a
couple thousand variations. Well maybe yes, maybe no. Like I said, it is not … This is not
one of those black and white things at least from my point of view where I can say, “You
know what, if you’ve got more than five variables or if you have done more than 5000
optimizations you have over-optimized it.” It is not that simple.

For me at this point it is mostly feel. I will sometimes do 1000 and feel I am fine,
sometimes I do 1000 and feel like, “You know what, I have over-optimized it.” Then I will
go to the other extreme. I will do on optimization running with 20,000 and feel like you
know what, I haven’t over-optimized it yet and a lot of it is feel. A lot of it also is also the
way I look at it is let’s say you have done 20,000 runs at the end of the day you’re looking
for one of these runs to trade.

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Well can you pick some run that you want to trade – what do the runs around it look like?
That to me is more the important part. It is, “Okay, so you’ve got,” when you tweak the
parameters slightly from the one you picked, do you still get similar results or do you
results suddenly fall off a cliff? That’s even more important in my book than over-
optimizing is not picking a result that when you start to tweak your parameters you go
from a great system to a system you will not trade. That’s in a sense where I may be kind
of get around the question of over-optimized is take a strategy that is not sitting on a cliff
or also not necessarily sitting on the peak but maybe near the peak, not necessarily on
the peak. Does that make sense?

Andrew: Yes so it’s the consistency of the results based on the variables around it.

Cesar: Yes.

Andrew: Okay, so that’s interesting. I guess that’s going more towards the art of back testing which
is difficult to quantify it is not just the science of it.

Cesar: Yes, it is definitely I think it is more of an art. Some people will think – you’ve got more
than three variables, you have over optimized. Like I said at the end of the day, you trade
your own strategies. So you’ve got to be comfortable with what you’ve done. In a sense
you’ve got to live with what you did, you’ve got to go try to make money off of that. So if
you think you have over optimized, well you’re going to be uncomfortable trading it so
you probably have and you think you haven’t then good, that’s good too because then
you will have confidence in trading it.

Andrew: Right. So you also mentioned one of the challenges with backtesting is data.

Cesar: Yes.

Andrew: How do you split your data when you’re testing? Do you use in-sample and out-of-sample
data for that?

Cesar: No I do not. This is again I know certain people who have probably now, they are standing
up and screaming at me for saying this. I do not believe in using in sample and out of
sample. Again this is back to our black and white and gray thing – some people think this
is black-and-white. I think it depends on the person. Here is why I do not use in sample
and out of sample data. And like I said, this is just my opinion. I developed my strategies
and this is why I trade my strategies because I am comfortable this way.

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Let’s say you have 10 years of data and you want to use the first five years as your in-
sample and the last five years as your out-of-sample. The problem I have with doing
something like this is here is how most people will do it. They will take those five years,
develop their strategy then run it on the out-of-sample data and say, “No, that doesn’t
look right. Let me try again.”

You know what, you are ready to get one bite of the apple and if you’re going to be really
true to in-sample out-of-sample you should just stop right there and just throw away your
idea. The problem is 90% of people don’t do that. They say, “That wasn’t quite right, let
me do it again.” And you know what at that point you have just blown the whole in-sample
out-of-sample problem. So that’s one reason I don’t use in-sample/out-of-sample.

The other reason is it’s back to data. I like when I test I like to test probably on an 8 to 10
year look back and the reason is kind of on that timeframe is I want to go through one
bear market, one bull market, one high volatility timeframe and one low volatility
timeframe – that usually coincides with a bear market and bull market and I don’t like
going farther back. And you could say I could do a test right now starting 2005 which gives
me 10 years of data, little bit of a bull, a bear followed by another bull, both low and high
volatility timeframes. You may say, “Well why don’t you go back to 2001?” And the reason
is the father you go back the less and less I trust the data. And markets just change. That
market of 2001 is very different and I don’t think it is going to happen again.

Structural changes have happened also to the markets throughout the years. In 2001 we
had penny pricing show up so I believe that structurally changed the markets. In the mid
2000 we had a high-frequency trading show up and we had the access to data and easy
to access back testing show up that also changed markets. So that also causes problems
for the in-sample out-of-sample.

Well if I go back 10 years, I review the first five years of my test – this in-sample, when I
am going to go through the major bear market of 2008 and then the last five years, our
major bull market. So it is kind of weird that you’ve got and in-sample that’s covered a
major bear and your out-of-sample covers our major bull and then people say, “Well you
are out, go back farther.” And well, that gets into my problem of well, I trust the data less
the farther you go back and then the market was just very different and not likely to
repeat that from back then. So that’s been my long way of saying why did I don’t do in-
sample/out-of-sample. Some people are religious on that. To me that’s my reason for not
doing it.
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Andrew: So if you’ve back tested say the last 8 or 10 years up until today and you have a strategy
that you would like to start trading, do you start trading that immediately?

Cesar: I usually start trading that within a month. What I would usually do, so I would get the
strategy, I would figure out which one I like, I will develop then the code that generates
the signals and then I will just generate those signals for a month, mostly for a sanity check
to make sure I haven’t done anything silly, to make sure the signals are being generated
correctly and I will start trading.

At the end of the day what really counts is – does the strategy make money? It is not –
how did it do in the backtesting? But – how does it do going forward? And the only way
to do that is to trade it live.

Usually I trade it; when I start a new strategy, I trade it full-size, whatever size I was
planning on trading it I start trading it at full-size and just keep an eye on it. Especially the
first three to six months I make sure – is it behaving the way I expect it to in the current
marketing environment? Just making sure – is it meeting my expectations of volatility?
Maybe there is some looking for – this is usually what I find, potentially find any
programming errors that I might have done when I originally wrote the strategy. There’s
nothing like putting real money on the line to really make you look hard for your bugs in
your code.

Andrew: That’s right, yeah. You mentioned the changing markets over the last eight or 10 years.
Early 2000, mean reversion strategies did pretty well but it seems that the last couple of
years returned have been dwindling. Why do you think that is? Is mean reversion as a
strategy dying?

Cesar: I think a couple of factors come into play here. First mean reversion is not dead in my
opinion. Last year my mean reversion strategies did pretty well. My overall account did
not do as well as I liked but my mean reversions more than held up their weight.

Now are they doing as well as they did in the early 2000’s? No. I attribute this to two
reasons and in fact one I already mentioned. One is I think high-frequency trading has
really what I called softened the selloffs and the subsequent recoveries of stocks in the
short term. So I think some of the returns have been eaten away there. And also there is
a lot more people. In the early 2000s; 2003, 2004, 2005 when I first got into this. So people
really didn’t talk about the style of mean reversion. It was not a big topic in the area, the
Internet was not as big as it is now. Now everyone does know about it, everyone trades
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it and therefore you just got a lot more people trading it and the edges have just gotten
a lot smaller. Do I believe they are gone? No, not my testing and my own account say they
still exist. Do I believe they have gotten as profitable? Unfortunately no, they are
definitely a lot less profitable but they are still profitable enough for me to trade.

Andrew: Thank you. A lot of the books, the Connors books that you are involved in publishing seem
to prefer exits based on technical indicators or price behavior other than using fixed stops.
Why is that?

Cesar: Because they don’t work 90% of the time for mean reversion. It is a simple as that. I
remember probably 2005 when I first started working for Larry Connors, we were doing
some strategy and of course at that time it was, you’ve got to have stops, you’ve got to
have stops, you’ve got to have stops. Larry sent me some research saying okay, “Whatever
okay there is a trade and you get in and then you’ve got whatever, your 5% max loss stop
and your 10% profit, I’m just making this up off the top of my head.

I ran these numbers and it all looked great and everything and then it was like, “You know
what, what happens if I make the stops bigger?” I slowly made the stops bigger and bigger
and bigger and it finally got to the point where it’s like, “What if I just get rid of the stops”
and every time I make the stops bigger, the results got better and when I got rid of the
stops, the results got even better!

At the end of the day the stops are a psychological insurance. If the stops help you trade
and stick with the system, great – use them. But it is insurance and insurance costs you
returns. So 90% of the mean reversion strategies that I have traded in the last 10 years do
not use stops. Mostly just because it does not work – I should not say does not work,
greatly reduces returns. And then usually the follow-up question is, “Well, what do you
do?” I handle it by position sizing. I position size such that if for some reason the stock
were to slowly dribble down, it would lose 25, 50%, it would not kill my account. Now
psychologically it may be a little bit painful but it will not kill my account.

And the reality is, most stocks don’t usually dribble down 50%, they open down 40% and
the stop would not have done you any good. So that is why I don’t use stops most of the
times. The funny part is on that whole equation, the leverage ETF strategy that I have a
service for and I am trading does use stops. And I think why it works here is because these
are indexed and these are leveraged ETF’s and what I’m trying to basically catch the
bottoms of these balances and if I don’t I get out. That is one of those rarities where it is

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the first time in a long time that I am using stops in my own personal accounts. It drives
me nuts though watching, getting stopped out but that’s the way the strategy works best
with and that’s one of the rare ones where even a mean reversion strategy was working
good with stops.

Andrew: So that’s a very interesting perception because I guess when we all start trading, it is
drilled into us that you always need to use stops but it goes back to one of your initial
comments that you need to trust it but verify.

Cesar: Right.

Andrew: I guess you could say your stop is sitting at zero right?

Cesar: Yeah, you could say my stops sitting at zero. I have to say without… Off the top of my
head, the worst loss I probably had that was not because of a large gap but a stock just
going persistently down was probably in the order of 30 to 40%. I know you are probably
cringing at that number but it is not like it happens every month. It might happen every
once a year, once every other year now granted I have had larger losses because of a
stock opening down 50%, I have had that happened I think my worst was last year, I had
a stock open down like 70%.

Andrew: Ouch.

Cesar: At that point, I mean at that point a stop would have done you absolutely no good and
actually in that particular case, it would have hurt you because it opened down because I
remember it bounced huge too. So it ended up being only a 50% loss.

Most of the times, these huge losses that people are trying to avoid you can’t because
they are overnight gaps and there is just nothing you can do about those.

Andrew: So if a stock does gap down 50%, or a percentage outside of it’s normal behavior, do you
continue holding it until you get a proper exit?

Cesar: Yes. The reason I paused is it is psychologically insanely hard to hold those but in my
testing it usually pays to hold, they usually bounce. I mean you’ve got to remember, let’s
pretend, let’s do this thought experiment in the sense of let’s pretend the stock dropped,
you’ve got $10,000 worth of stock and it dropped down to 50%. Now that’s $5000. The
major damage has been done already.

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At this point the stock is down 50%, the major damage has been done. So I am right now
looking, just waiting for that bounce. In my testing it always seems to be better to wait
for that bounce. Now is that to say a bounce will always happen? No. Sometimes you
know what? It would have been better just to get out that day but you play the odds.
Quantified trading is not about knowing for sure. It is knowing, “Well, if I do this enough
times, my edge will show up.” And I know well, if I get enough 50% losers, well thankfully
I don’t but on average it pays to hold them, to hold for that bounce.

Now the key point of all of this is there is two key points in all of this though. One is you
need to have a plan going in before this happens meaning you know what if
psychologically you can’t handle it may be your goal should be – “if the stock opens down
50% I just get out.” There is nothing wrong with that as long as that is your plan ahead of
time.

Making your plans during, while something is happening is the absolute worst time to be
doing it. And the other, this is something I have mentioned before, I probably really should
do a blog post on this, is trading can be a really solitary endeavor and it is really good at
times especially when your strategies are going poorly or one individual stock trade is
doing poorly that you talk to somebody. And I always say it is really good to have a trading
buddy.

I have a good friend of mine, I have known him about 11 years now, he’s my trading
buddy. You know what, if I had a stock that opened down 50% I have got an email or text
to him going right away saying, “I just lost at the percent on a stock.” And we will likely
talk that day and he will make sure my emotions don’t suddenly take over and I decide to
get out emotionally. He will remind me, “What‘s your plan?” It would be like, “Well, my
plan is to wait for it to bounce.” “Well good don’t get out of it.”

So that helps me follow the plan. You could have a plan but it is hard to stick to it and
having somebody else to talk to and hold you accountable to that plan really, really helps
– having a trading buddy really helps you through hard times in individual stock or are
times when your portfolio is just getting crushed or the market is getting crushed –
making sure you stay to your plan.

Andrew: That’s a great tip actually, having your trading buddy to keep you in check, so thanks for
sharing that one. It’s a great idea. You’ve mentioned a couple of challenges,

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psychologically with trading mean reversion strategies, perhaps that type of trading is for
particular people. How do you find a strategy or system that fits your personality?

Cesar: Well, unfortunately this falls into the really tough, at least for myself and I think for a lot
of people is you don’t know until you trade it. A lot of things, a lot of numbers look great
on paper. It is like, “Oh yeah, I can handle…” Remember very often when I was working
with Larry is we put out strategies and different variations of a strategy and people will
always kind of go to the strategy that has the highest return. The highest return also tends
to have very high drawdowns of 20, 30, 40%. And something I quickly realized is even if
people claim they can handle high drawdowns of 20, 30, 40%, actually 20% is not that
high in my book, most people start to freak out at a 10% drawdown.

I know only two traders that I have met and have confidence in what they have told me
who can handle drawdowns of over 40% and they regularly have drawdowns of over 40%
just because they are very aggressive. But they can handle it. Most people can’t. And the
problem is when you look at something on paper and say, “Oh yeah, I had a 40%
drawdown but next year it was up 100%” or whatever people say, “Yeah, I can handle it.”
You don’t know that until you trade it.

It took me a long time to find what I like. Like a lot of people I tried daytrading and after
a couple of months of it, I realized you know what, it is just not my cup of tea. So a lot of
it is, really one thing I advise is don’t paper trade. I think paper trading just does not show
you your emotions. There is nothing that will dig at you like real trading when real money
is on the line. Yeah, you don’t have to do a full size but do real money with maybe a third
the size or quarter the size or even 1/10 of the size, enough such that losing the money,
make sure you are kind of annoyed. And that is when you will find out whether, how much
of a drawdown you can handle or whether a particular strategy fits your personality.

Some things are easy in the sense of okay I’ve got a job so therefore I can’t be watching
the markets during the day, so that obviously makes it really easy to say certain types of
strategies, you have to be watching the markets during the day. It may not happen or
work for you but maybe you can’t handle buying pullbacks and you want to be more of a
breakout trader because psychologically it makes it easier for you to buy which is fine but
again alot of it I have discovered is unfortunately pure trial and error, you’ve got to try it
and say, “Yeah, can I stick to…” It is easy to stick to a strategy when it is making money.
When it starts to lose money really is when you find out – Is the strategy really something
you can trade?
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Andrew: That’s some great tips there, thanks again. I would just like to move on to your website
TranquilityTrading.com. You offer a couple of trading strategies there called Weekend
Stock Trader and Leveraged ETF Trader. Can you explain a little bit more about the style
of these strategies?

Cesar: Sure. So weekend stock trader is an S&P 500 rotation strategy. On a high level, it is
basically looking for a recent selloff and then a bounce – the bounce hasn’t been
excessive. Both of those strategies I trade variations of them, not necessarily the ones
that are up there because not because I don’t believe in those but because I mean I will
tailor any strategy to meet my risk profile exactly to what I want.

And what I like about that strategy is it doesn’t take a lot of time. It takes me about 5
minutes on the weekend to do, it gets me exposed to the S&P 500 and most of my typical
mean reversion strategies tend to have the smaller cap stocks in them. I am always
looking for something with exposure to the bigger cap stocks and that gets me that
exposure and it tends to be also in the market much more often. It is meant to be in the
market more often and that catches it but also it’s got all my strategies, try to limit, all the
strategies I personally trade try to limit the downside risk. And I try to stay away, I’ve got
a market timing indicator in there that gets me completely out of the market and then
I’ve also got a filter for the individual stocks.

I mean the individual stock start showing too much downside volatility I just throw it out
from consideration from trading because again I am trying to avoid the downside
volatility.

But is it going to be perfect? Of course not. And this actually gets me to… I’m going to go
a little off topic here but on these strategies themselves that I have on Tranquility Trading
and just peoples own strategies. People seem to think that strategies should make money
every month or should beat the market every year. You know what I think that is a noble
goal but an unrealistic goal. If you are beating the market every year handily, you should
be managing a lot of money kind of thing. Sometimes your strategies get out of sync and
that is something people need to realize. I know it was a little bit off-topic there but that
came up; now on to Leverage ETF Trader?

Andrew: Sure.

Cesar: For me I have always been looking to try to find something on the ETF side. I was working
with a fellow researcher David Warminster and this is a strategy he originally came up
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with an idea then I tweaked the idea to really take it to the next level. And this is again a
mostly a mean reversion strategy in on index leveraged ETFs and this just looks again,
looking for taking an edge of more of the index.

The index can sell off sometimes but you are just not getting a lot of triggers on the typical
stock mean reversion strategy. And this strategy takes advantage of those times and also
typically you need to use the leverage when you are trading ETF’s if you want to get
decent returns and that is what is the good part about this is if you use the index leverage
ETF’s both long leverage ETF’s and the inverse leverage ETF’s to get some good returns.
But because of that, we are also using some stops to make sure, when we are using
leverage ETF’s, the losses don’t get too big on us. That strategy is just a recent edition and
I have started trading it and it’s been very interesting trading it and seeing how it’s going.
We’ll see how it goes for the rest of the year.

Andrew: You just mentioned market timing when you were talking about The Weekend Stock
Trader. Can you explain a little bit more about that?

Cesar: Sure. In the simplest sense what I mean by market timing is some sort of filter or some
sort of rule that I apply to the S&P 500 index to say whether I want to even consider
trading the strategy and this is not what is being used on weekend stock trader but very
simply what I often write about on my blog is using the 200 day moving average. And just
say you know what, “I am not taking trades at all in this strategy when the S&P 500 is
below its 200 day moving average. Things like that, they just keep you out of the market
when things get really tough.

Often though, those are times when the strategy can also do very well but at a cost of
much greater volatility to your portfolio. So that is something that needs to be taken into
consideration is like if you are trying to have higher end returns, sometimes ignoring
market timing works to your advantage or just changing it slightly.

But like I said, I tend to focus on minimizing drawdowns and the easy way is just some
sort of market timing indicators to say you know what, the market is just not at a good
time, that it’s a dangerous time to be trading the market on the long side during these
time frames.

Andrew: Right. And I guess as well that the weekly time frame may be a little bit foreign to people,
when we start trading there is an assumption perhaps that to make big money we need

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to get into the smaller time frames, like daytrading and do lots of trades. How did you
come about looking at the weekly time frame?

Cesar: Yeah. I mean it kind of is. I have to agree with that. I think as you compress your
timeframe, the higher your possibility of annual returns. But like I said, on this particular
weekend stock trader I would not say, “Oh, I’ve got to make these huge returns.” I knew
by going to the weekly time frame my returns would be less but what I was giving up for
that was my time commitment to the strategy, it is one of those I knew ahead of time.

Okay because I trading weekly my returns would be less but because my returns were less
I get less of a drawdown. But it is going to fill a whole bunch of different things. It gives
you less returns, that’s okay but it gives me exposure to the large cap S&P 500 stocks
which my other strategies did not and by being forced to be in a weekly time frame also
by taking trades and holding it for five days, you give it a little more extra time for its
potential bounce and sometimes instead of getting out a little bit early but it is the typical
mean reversion you may want to hold a couple of extra days and get an extra return out
of it.

So again, it was just trying to mix things up for the strategies I was doing.

Andrew: So why do you like to mix things up and try different strategies?

Cesar: All strategies aren’t working all the time. Strategies go in and out of sync with the market
and I currently trade one, two, three, four different strategies and I don’t expect them all
to be making money all at the same time, I actually hope they aren’t that way. I want
them to be maybe when one is strong one is doing a little bit weaker and that is why I try
just to mix up my strategies even though most of my strategies tend to be mean reversion-
like I still try to make them different enough that they are not all in the same stocks or
the exact same sectors or things like that, just make them different so they are not all
chasing the same general thing. And definitely discover that last year my mean reversion
stuff worked pretty well last year. My rotation strategy worked less well last year, I am
not sure how they are doing this year, I would love to have a look to see. I usually don’t
look, I look in three-month chunks so I guess I’m all most into the third month so I have
to take them up and see how my strategies are so far doing this year.

Andrew: Right okay thanks for that. So I might just wrap up now with some general trading
questions.

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Cesar: Sure.

Andrew: What’s the biggest lesson you have learnt through trading?

Cesar: The biggest lesson I have learned is what to do with trading mistakes and have a plan for
how to deal with them. And what I mean by that is you actually type in the wrong symbol
what are you going to do? You have to plan ahead of time. I have seen so many traders
really screw that up and I have screwed it up myself, of knowing what your plan is when
you make a trading mistake.

Andrew: All right, okay. So this probably links to the previous question, what is the best trading
advice you have ever received?

Cesar: Yeah, it is cliché but, “Have a plan.” Know ahead of time. The wrong time to be making
your plan is right in the middle of your trade.

Andrew: Can you share one of your personal habits that you strongly believe contributes to your
success?

Cesar: I am constantly doing research and I’m sharing that research trying to get feedback back.
That definitely was helping a lot.

Andrew: Okay. Thanks and what about a favorite website or online resource that you would like to
mention?

Cesar: I would mention too. If you are an Amibroker user, the Yahoo Amibroker boards are a
great way to learn, not to learn any trading ideas but more tricks and tips on how to use
Amibroker which I think is an amazing tool. And for trading ideas, Thewholestreet.com
(which is now called http://quantocracy.com/) Oh man, I just love the aggregation of
things. I get so many of my ideas from them now.

Andrew: Yeah, that’s a great website that one. Favorite trading books?

Cesar: Of course not counting my own books is actually a non-trading book. It’s any book by Dan
Ariely. He did “Predictably Irrational.” And the reason I like his books for trading is it really
shows you how irrational we can be with money and to me I think a lot of even Quantified
Trading still there is a lot of emotional part behind it just understanding that an
understanding yourself and all the stupid mistakes you can do, I think those books really
help my trading.

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Andrew: Great. And finally what is the best way for listeners to get in touch with you?

Cesar: Yeah. If they go to my Alvarez Quant Trading blog, there they can read a whole bunch of
my strategies, things like that and you have a contact form there if you want to contact
me about any questions about, anything like discussed in the interview, they can do that
there. And also to any of your listeners if you go to my blog now you will see that my
Amibroker one-to-one course is currently closed but if you mentioned that you heard
about it on this interview here, I will open it up just for you. I don’t know when I plan to
be open up that Amibroker course, it is currently closed mostly because of other projects
that keep me really busy but if any of your listeners are interested in taking that I will
open it up just for them.

Andrew: Thanks a lot for that offer there. That’s very generous Cesar. Thanks so much for sharing
your knowledge and experience with us today. Is there anything else you would like to
mention before we wrap up?

Cesar: No Andrew. Would just like to say thank you very much for taking time to talk to me. I
always love talking about this stuff and if you have any other future questions, just
definitely shoot me the email.

Andrew: Oh, fantastic. Thanks a lot. I highly recommend everyone head over to the website –
Alvarezquanttrading.com. It’s got so much great information there you can, you can check
out more of Cesar’s work.

Thanks for your time today.

Cesar: Thank you.

***End***

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