Q&A with Thomas F. Basso, CEO and Trustee of Trendstat Capital Management, Inc. a successful investment advisory firm in Scottsdale, AZ. His mathematical and computer background has given Mr. Basso the ability to develop a wide range of investment programs to take advantage of opportunities in the financial markets. He has authored Panic Proof Investing, and was one of the traders featured in The New Market Wizards.

Give us a little background on how you got involved in the market and some of your philosophies.

I started out as a chemical engineer and got a little bit bored with chemical engineering and wanted to invest my own money in the stock market and one thing led to another and pretty soon I started managing money for myself and other people. I got into the investment advisory business, later got bored with stocks, started trading commodities, ran into some capacity limitations there. Started dealing with currencies, took over another firm's program started trading futures and now I've expanded a little bit more into the mutual fund timing area and hedge fund world an evolution of some 23 years. People still think of me as a trader, because I've got so many years in the business, but in reality I'm CEO of Trendstat Capital Management which tends to put me in a position of directing the Company's future, dealing with strategic projects for the Company, designing new strategies, working with the Research Department on where we're going with our research, things that are very long term in nature. The day to day trading, we have a department that just does trading. We have a full computer department with software engineers. I used to do the programming, the trading and everything. Nowadays we have people replacing me in a lot of those functions so that I can be freed up to do the highest value, it seems to work pretty well. So I haven't forgotten about trading, but I haven't physically traded for years probably now.

From the standpoint of having the whole thing mechanized, the more obvious question is - How do you overcome the temptation to sometimes override the system and just say "I've seen this particular set up a million times before" if the system is not giving you that?

I have a few thoughts on that. One is that you actually decide to keep a diary and write down why you would override something and then go back after overriding, or potentially overriding, ten or twenty trades. Look back and see what the actual results were of your subjective decisions. I think you'll find, at least I found, that I added very little to no value and that as a logical engineer told me that I would be wasting my time to be concerned with overriding a signal because I wasn't going to be adding any value anyway so there must be something more important that I can do with my time.

The second approach you can take is one of just simply strategic planning. When you decide on a strategy, take the attitude that everything you want to do with that strategy must be laid out ahead of time. Force yourself to think of all the different scenarios that might face you, like you said "this particular trade didn't set up right." Okay, that's a realistic scenario. Include it in your strategic planning and ask yourself, if this doesn't set up right, what would I want to do? Would I want to override it or not? And if you get the answer to that as "I don't know," well then research it. If the answer to that is "I definitely would override it," then build it into your strategy. Whenever you don't do the set up, you don't do the trade. Now it's part of your strategy. You still don't need any discretion. A lot of times I think discretion overrides on systematic trading is nothing more than an emotional appeal to the trader to get the adrenaline flowing and feel like they are part of it. And if you're truly just trying to crank out a profit on your trading and you're not using trading as a proxy for either gambling or excitement or something else in your life that you know you're missing out on, I think that you will find that you don't really need to override a lot of strategies. There may be very rare instances that you can't figure out ahead of time, then simply ask yourself; "Why do I want to override this?" And you can almost systematize that too. That's what I've done over the years. And if there is a legitimate reason at all to use discretion, I build it into the strategy. And if you think about it, when you're building a strategy, you're using total discretion because you are starting with a blank piece of computer code, you haven't written a single thing. The computer is absolutely stupid and I tell it how to trade. I'm starting with the full discretion to do it any way I want and there's a lot of discretion in building a strategy. I put it in up front rather than doing it each day.

For someone to follow a systematic strategy --

System implies computers and I think strategy is a better word for an approach to trading because it includes all those discretionary folks that also have strategy. But they are somewhat repetitious in their strategy. So I think strategy is something that is used globally, it appeals to all traders so it's an easy word to use.

With that clarification, I guess the next question would be "You have developed that approach with a system that you know works. You've seen those set ups, you know that those work. Let's take the example of someone who is completely new to trading or day trading, or investments for that matter, if they want to get involved, how can they develop a systematic approach? Or better yet, what are some of the preliminary things that person is going to need to do outside of not only finding a methodology?

The first thing they are going to need to do is find a very quiet time get a paper and put down what they think is an inventory of themselves. For example, how much money am I going to have to trade? How much extra cash flow in the future can I add to my account? This is just a partial list. I couldn't possibly give you the whole list. Are you a short -term oriented person or a strategic thinker? Are you a relaxed person or are you hyper all the time and fidgeting all the time and you're just going to be a Nervous Nelly all the time? Do you have a lot if math skills or none? Are you good with a computer or not? Do you have floor experience or none? Do you have fundamental experience in the market that you are going to trade or none? Within all of this inventory you're going to start flushing things out "Well, let's see -- I probably should stay away from computers because I don't know anything about computers. Well, may be I can deal with graphs, graphs on charts and maybe I can figure something out. Do I want to be short term? Yes, I think so, because I am a nervous person." So little by little you'll eliminate a lot of areas.

In my case, I was in strategic planning before I went into money management. That tells you about my time frame. I'm very long term in my thinking. A lot of people would accuse me of spending more time living in the time frame of five years from now than today. I spend a lot of time thinking about where everything is going and what should we be doing in preparation for it. That's where I live a lot of my life. Especially as CEO of Trendstat Capital Management. So strategic is no problem for me. I'm very patient. I have as much patience as anybody I know, with respect to trading. At least I know if everything is in place strategically it will workout. I can be impatient when things aren't done in a quality fashion, but that's a different issue. I think in terms of long term plans, I am very patient to let them work out. So again, long-term trend follower would be perfect for me. I am an engineer by background should I use math and computers? You bet! I should probably just do it all by math and computers, which I do.

What we've done is we've matched everything that we're doing here at Trendstat to exactly my inventory. How much money I could afford to get started, what types of resources I could bring to bear on the problem, the timing. I'm not able to do things intra-day with those computers, I don't chose to, it doesn't seem to add value, so in my case, we do once a day decision making and we run our computers once a day on the close. We get our orders all set for the next day and repeat the cycle 24 hours later. That's the cycle that exactly matches our skill levels, our resources, our personnel, our equipment. That's what the aspiring trader has to determine. If you're a traveling salesman and you want to get into trading and you're going to be on the road five days a week and you can only work on your trading on Saturday, then you come up with a once a week strategy. That's perfectly acceptable. Doesn't mean you're any less of a trader. It just means that's one of your particular resources and limitations. And you have to build everything you're going to do around that. If you try to mismatch it, you'll really screw yourself and you won't be able to achieve what you want to do.

I think when you made the point that if you get into a trade that has been set up in a quality way, I think is how you phrased it, you're very calm, probably even detached at the time and let the trade go where it may. Then, of course, you said if maybe three out of the five pieces are there, suddenly you're not quite as comfortable. I've noticed that a lot of people do that when they are trading. Maybe they get in for the wrong reason and suddenly they're really fidgety about the trade. But it brings me to another aspect of the subject. If you go through a mental checklist and inventory your personal strengths and weakness, you then need to match those characteristics when seeking out someone to mentor as a way of learning to trade. I've seen a lot of people try to mentor with other traders to try to learn the ropes, to learn their system, but it is obvious that mentors trading style has to meet their own personal strengths.

Which creates a problem if the mentoring trader doesn't understand what has made him or her successful and doesn't relay the principles that were involved instead of just the details. In other words, a guy like Paul Tudor Jones and myself couldn't be farther apart. He's a discretionary trader and I'm a systems nut; and if you stuck him in my chair and me in his chair; we would be fish out of water for the entire day. We would have no clue what we were doing with each other's business, but we're both pretty successful at what we do.

I've been doing mentoring for some time now. What I've come to realize after doing it for a long time is that the people who have shown the most promise are the people who are most like me in many ways from my personality standpoint. So I guess one of the things we need to identify is how do you identify that person from the beginning to not only save them their time, money and effort, but also to save you some hardship?

For that what I would do is profile psychologically of you, if that was the game. If you were looking to hire a whole bunch of people to trade the same strategy and make them all successful, you would want to profile yourself and then figure out what that is and then profile everybody else. Either that or you need to group people by different profiles and once you understand the different profiles, make some suggestions to them on concepts of what things have to be in place, but don't give them the detail of just the way you do it. Give the basis behind why you do it. You cut your loss here to limit your losses. But that's global to all strategies. Don't talk about the details of why you cut your loss right there. Encourage them to come up with their own strategy for cutting losses short that works for their philosophy and their resources and their skill level.

Basically, what you just indicated is that not only is the trading very systematic (not only from your perspective, but also from mine -- although not quite to the degree that yours is) but you even have to take the mentoring thing to just as scientific a process. It's not as simple as saying "That guy wants to trade here, okay cool." You've got to bring him or her, profile them and make that determination.

In the end, I think every trader should develop his or her own strategy for buying and selling, for money management and for dealing with him or herself. I think there are people out there, like Van Tharp which will tend try to come up with some outlines or some ways of mechanizing or getting people to think through psychological dealing with certain things. They will come up with exercises for helping you understand yourself, or building your self-esteem and other things. And that's all good, but in the end, what I think you will find is that different traders would gravitate towards different exercises and one guy likes the first exercise and the next guy likes the second one. And what happens is as long as everybody is getting to where they need to get to, who cares. But it isn't as easy as having a "cook book" approach that gets everybody clued into how to reduce stress levels, how to detach themselves from the trading, and so on. I did all this even before I met Van Tharp. I had to develop my own just out of necessity. Everybody that I know that is successful in trading has developed different ways of dealing with their own mental processes. And it's important and Tharp gives you a very good approach to it and so do a number of other people out there doing consulting these days. I think in the end you need to grab on to one that works for you and come up with your own money management modules and you have to come up with your own buy/sell engine to decide where you're going to get in and out. It doesn't do you a lot of good to just copy someone else's, that's not who you are.

It may work if you've got somewhat of a similar profile to understand the mechanics behind it but ultimately it needs to be fine tuned to meet your own personality quirks.

Exactly, all personality quirks, risk management, risk tolerance, time spent, the whole gamut of who you are.

Going more to the management side of it, in terms of how you determine your entry and exit points. Trading is either long-term or short-term. Do you see any parallels in terms of what you do on a day to day basis and what a day trader may do on a day to day basis?

I sure do. In every case, to make profit you have to either buy low, sell high; or sell high, buy low. That in a very global sense if you step all the way back, is trend following, no matter what you want to call it. In the 70's, they talked about everyone being trend followers, well they're talking moving averages, and all that. I don't think that's necessarily the case. I think you can come up with a lot of other fundamental reasons. You can take a guy like Paul Tudor Jones, a discretionary trader or some of the big floor traders of the world. Hey George Soros has made a lot of money on shorting the British pound and he might have fundamental reasons because he maybe knows a guy from the Bank of England or whatever. But the bottom line is that Trendstat, who doesn't know anything about the British economy was in on the same exact trade as Soros, and made a bunch of money too. The thing is that large trends, large movement in the market, are going to create a lot of opportunity. Don't get hung up too much on the buy/sell decision engine on where do you want to buy and where do you want to sell. Because in the end, large movements are going to probably create most of your profits. And that goes for short term trading and long term trading alike. Short term trading you get in and lose one thing that was in your favor and it turns around on you and you have to blow out of it, it's not going to do you any good. You've got to have the big trend. Sure there are the trends in the short term in the day trading or a smaller trend in the big one. But hey if you put a day chart over on the wall or a tick chart over on the wall or if I put a daily chart and I walk across, they all kind of look the same from a distance.

A trend is a trend regardless of the time frame. And that's what we've been finding somewhat difficult. We get a lot of these indices that trade in somewhat of a range, and it makes it difficult to trade back and forth.

Especially when you've got the fixed overhead of commissions every day as opposed to, in my case, I might hold a position for two or three months. It's a lot easier to overcome the cost of trading.

I've read in your book and others about the randomness theory (that the markets are random and cannot be consistently beaten). So do you want to give your two cents on the whole randomness concept.

I think there is a new genre of finance called "behavior finance" that I think addresses better the whole concept of what makes economies and markets move and I think it's becoming more widely accepted as more research is being done and it basically says the economies and markets are driven in the end by people making decisions and that people in the aggregate, any one person , doesn't really change their [his/her] mind all that frequently. In other words, if I look at anyone person that might be reading this interview and I find out how they go through their day-to-day; and then I go some Friday six months from now and I look in on him and I see how they spent that Friday. We might discover that a whole lot of their day isn't all that much different. They're probably living in the same house; they're probably eating similar foods; they're weight is probably somewhere around where it was; they probably slept the same number of hours. There are lots of things in their lives that stayed the same. The kids are the same, the wife is the same. Yes, there might be some things that changed, but there is a lot that stayed the same. So that there is a very small degree of change, even with one person. But you can imagine, if we dumped everybody into a big pot and called it an economy, now we statistically are going to have one guy getting a little bit of a change to make things go faster and another one tries to slow things down and they equal each other out. So the aggregate decision making of all of them really is very stable. And because that's the case, I don't buy the fact that there is a random theory because it presumes that all this information is just randomly coming out and that all these people are just making 'wacko' random decisions on what to do with it. It just doesn't make any sense it doesn't feed into the psychology of the people making those decisions which I think are very predictable in the end. One could say that I guess we've been lucky for twenty-three years. There are too many traders that have been around too long and know how to manage money well and proven beyond a shadow of a doubt, I would think. Well the random theory would say we'll take 10,000 traders, there's bound to be 50 of you guys that did okay. Well, the fifty traders that did okay are laughing at that study.

We never really looked at it from the narrative that you've given, but we watch the S&Ps pretty much tick for tick all day, the S&P futures and one of the reason we found (and it probably goes back to the whole crowd thing that you just discussed), we're aware of some of the support resistance lines interday on the S&Ps. They stop on a dime. That to us just indicates that there just can't be a whole lot of randomness to the market if everybody's watching the same thing.

My answer is that if you took say 10,000 people to coin an analogy completely away from trading, and you decide that being able to make a free throw from a basketball free throw line is a random occurrence, out of 10,000 people, is that to say that a Michael Jordan is just one of those rare entities. He doesn't really have the skill, he's just gotten lucky over all that time. That's almost the same thing. The traders that do a good job know why they did it. There's a few exceptions to that. There's a lot of people, in fact some in Market Wizards and New Market Wizards, that Jack Schwager wrote about that are no longer around or suffered some very dear, heavy losses have slowed up (Victor Niederhoffer syndrome of course) there have been others. I think if you study their psychology, why they're in the market and all that, I think there were some flaws in what they were doing and they were lucky for some period of time. Those are the cases where a lot of times the professors will cite these people as being lucky. And perhaps they have been. Perhaps there have been some psychological problems there where they've felt a deep seeded need to not be successful because they feel guilty about being successful. Some people can't handle wealth. I can't tell you how many people think wealthy people are unhappy. My mom used to say over and over again that people who live in big houses or have a lot of money are not happy people. I don't agree with my mom and fortunately, I grew out of that philosophy and I feel very comfortable with what I'm doing. But there are some people that don't and they try to hide their wealth and they try to down play everything and that's kind of absurd. You are who you are and you have to feel good about it.

You just brought up a pretty interesting comment that I was not aware of. You indicated that some of the people that were interviewed in the Jack Schwager books went on to blow up or not become successful. I guess I'm speaking for myself I assumed that once I got over that hump and started to do this consistently and make income from it, I thought "Hey, I made it, as long as I keep on top of the game, I should be able to do this as long as the markets hang around, I should be able to do this for a long time to come." I imagine those people thought the same thing. I guess my question is how could you know that what you obtain is a fluke or " random" as the academics would say or how could some one who has done extremely well in the market for years suddenly find themselves completely out of sync?

I think it comes from understanding what got you to where you were in the game. In my case, I know exactly the reasons why I do what I do. I know exactly the Achilles heel of everything that I do. So I know when I 'm having losses, exactly why I should be having losses and I have to have a belief in myself that these losses are not going to continue forever because the markets are doing what they normally do and nothing is out of whack here and don't go panicking and changing anything. Just 'keep on keepin' on.' Watch your risks. Don't leverage it too much. Don't try to push the envelope. All these things that I know about how I've gotten to where I've gotten to, have been time tested for 23 years now, so it's not a flash of success where I had one year with a 1000% and pyramided it ten times and now I'm worth as much money and on the Forbes 400 list. I just happen to have a streak of good luck. It is ground out. I've had plenty of losses along the way; I've been seasoned I understand where the good points and bad points have been and I just crank at this point. Doing another trade would not excite me any more than breathing

Tom, this is John McConnin. A few years ago, after I had been trading for a while, making money consistently, and beginning to understand what was going on in the market, I decided to figure out how to take my trading to the next level. Around the same time I read Van Tharp's book, and realized that as long as I trade small, trade frequently with high probability set-ups, and with emotional discipline, I could trade any market as long as I keep the risk per trade low.

I think you said it perfectly well. If you understand what got you there and you want to go on to another challenge, another market let's say, I think you should do some research first to see whether the reasons you were successful in the first market also apply to the second. But I'm always exploring good new markets and new ways of trading. That's what I do. �We just did a brand new program called "Trendstat Serenity" and I had to build an asset allocation model for the whole thing. So over the course of several years, I've been doing a some experimenting and I've got a lot of data and I've built this thing finally and so far so good. They really like what it's doing and I understand how to build one of those models because I've built so many models over so many years--it's just doing another one. So you've got to take what you learn form the one market and say "does it apply to another one?" And if so, yes, now you can trade two markets if your resources and capabilities allow you to. If you're doing it all by a human being looking at a quote machine, you have to ask yourself "how fast can your eyes dart around the screen and how fast can your hands go on the keys and how many phone calls can you make? There may be some physical human limitations to what you're doing. But if you could automate what you're doing with your eyes and your hands and all your technique, and have a computer watching a hundred markets, and it applies across the board, there's no reason why you can't expand it almost to infinity.

As a scalper becomes more and more profitable, it is natural to want to increase the number os shares traded per trade. Unfortunately, this brings liquidity problems and higher slippage. The obvious solution would be to take longer time frame trades using the same methodology. What are your thoughts on that?

You have to understand how you did what you did on the short term and very carefully approach the new time frame because you're not used to that time frame and Tharp is absolutely right I believe. In my time frame where I'm very long term, you better trade less than 1% of your equity on every position. You better be patient. There's a lot that goes on there that you're not psychologically prepared for as a day trader let's say. It's a different game. It's not one that you can't achieve, but you have to try to understand yourself well enough to be able to make that transition. Going from say a floor to off floor trader, people have a rough time with that. It's not just me saying it's hard to do, there's just been a lot of examples of people trying to get off the floor or go from short term day trading to longer term strategy. And it's just not them. They are so used to their previous methodology, they just can't make the transition very well. Or they may not have the computer skills that I have, or they may have other limitations. They may not have the risk capabilities that I have. Or something. Make sure you have everything in place; do your homework. Walk before you run and all those good things. Build up your expertise just the same way you built up your expertise on the short-term approach.

Right. It's a comforting dissertation on the whole thing and the bottom line is; regardless of what the market is doing, if the way you're trading is not working right now and you're doing everything you normally do, its probably a result of the market many times. Once in a while, you go through some periods where your style of trading just doesn't seem to be working and then it goes away for a few days and then it comes roaring right back. I guess the key thing there is to not get discouraged and deviate from what got you there in the first place. That's kind of the bottom line.

Correct. If you understand that got you there, and you don't feel that it's something that has changed materially in the marketplace, in other words, the volume in the marketplace is gone because they're going to shut the market down, they're going to turn off the lights in the pit. If something material is going on and you just can't trade anymore, well that's different. Like you're trading German marks like we were two years ago and now you're going to have a Euro instead, well you're going to have to turn off the lights on the German market for trading, and turn on the Euro light and start trading that. So there are some things that do change and you have to make changes. So unless you see something material like that, basically it's just business as usual. Unless you think the markets have changed and you're having a bad time because the markets are feeding you a certain amount of data, they should give you some whipsaw trades or some lack of trends and therefore you should be losing. Don't be discouraged. In fact, if you follow your trading strategy that day, and it does not reward you, a good thing to tell yourself is when you go home for the day is; "I lost money and I followed my trading strategy to the tee, I should give myself two pats on your back instead of one because that's doubly hard on my psyche.

That's true.

Stay with it. But that's exactly what you should be doing as a good trader.

What I typically do when I recognize that the market's not setting up for my type of trade, a lot of times I'll sit on my hands. Would that be an advisable approach as well? Or do you run the risk of missing out on those few trades that may work?

No, if you, as part of your strategy, are looking for that setup, then I'd say sit on your hands all day. You are a trader whether or not you are making trades or not. A lot of day traders feel like they have to day trade every day or they're not a trader. And I argue that if you don't have the proper set ups and the proper conditions to pull the trigger, you wait and you wait and you wait and you wait. Just like the big cat waits for the herd to go by, and not only waits for the herd to go by, but looks for maybe a small animal that might not run as fast and then looks for a small animal that's injured or sick and gets everything in place. The setup is perfect, now you whip into action, you try to take that prey down and that's kind of they way you've got to look at the stalking process and trading. You have to get everything in place and then pull the trigger quickly and mindlessly almost.

IMPORTANT DISCLAIMER: Market volatility and volume may delay system access and trade execution.You can also lose all your money daytrading. Day Traders should be experienced and sophisticated investors. They should understand the risks associated with day trading and the high aggregate commissions/ticket costs that will occur in relation to the high volume of trading activities; and the capital used for trading should not be funds for retirement and they should be aware that account capital and margin credit may be lost and that such loss can be afforded and will not cause undue hardship.