Warrior Trading Blog

Hedge Fund Managers who got Rich from Trading and their Strategies

Hedge Fund Managers

Jack Schwager of Market Wizards fame defines a trader as someone who is willing to go long or short, and routinely changes their market positioning. This is in contrast to what he considers to be an investor. He encompasses the investor mindset as “I want to have 50 percent of my money in equities. I’m going to buy an index. I’m going to stay for 40 years.” 

Under this definition, he defines folks like Jim Rogers as a trader, even though Rogers himself doesn’t use that title, and mostly manages a longer term portfolio. 

If you look at a list of billionaires, you’ll find it crowded with hedge fund managers deploying a long-term value or growth investing strategy. Because of this, many in the finance world shine a negative light on the discipline of trading, claiming that ‘nobody ever got rich reading a chart.’

In this article we’re going to take a look at the careers and strategies of hedge fund managers who got rich through trading. Those who broke the conventional wisdom and took a different path in financial markets than most. 

Richard Dennis

Dennis’ story is one of the most well-known in the trading world, next to Jesse Livermore’s. He and fellow trend follower William Eckhardt are the real-life embodiment of the movie Trading Places, with their bet that a normal person can become a successful trader. 

When starting out on the trading floor, Dennis had $1,600 to his name, and his seat on the trading floor cost $1,200, leaving him with just $400. Dennis reportedly turned that $400 into $200 million, to which his father said “let’s just say Richie ran that four hundred bucks up pretty good.” 

Dennis managed several funds over the years, receiving backing from behemoths like Drexel Burnham and George Soros. His biggest problem with managing client money was the volatility. Clients would act prepared to experience severe drawdowns while Dennis manages their money, but would withdraw when it got tough. Even Soros pulled his $2 million investment after a 33% drawdown in just two months time. 

His worst drawdown was during the years of 1987-1988, where he lost more than 50% of his fund’s capital. Dennis had to wind down the fund due to these losses. Shortly after, Dennis retired from trading to focus on his political interests full time. 

Back in the 70s and 80s, Dennis had a rules-based trend following system that he was making a killing with. There was little or no secret sauce, it was simply following his trading rules to a T, and not deviating from them during a string of losses or when his mind got weak. 

In 1983, Dennis and Eckhardt had their Trading Places moment. Dennis thought that anyone, if given a set of rules to follow, can become a successful trader, while Eckhardt disagreed, and thought that there were innate traits unique to successful traders. To settle the debate, Dennis took out an ad in The Wall Street Journal recruiting novice traders.

After screening through the thousands of responses, Dennis interviewed 80 and took 13 under his wing. He called these traders his ‘turtles’, because he believed he can ‘farm’ new traders with the same ease that turtle farmers grow turtles in Singapore. 

It turns out that trading isn’t an innate talent you have from birth, but a skill to be nurtured. All in all, the inexperienced turtles earned over $175 million in five years using Dennis’ rules-based system and Dennis’ own money.

Like I mentioned, Dennis is a trend follower. He likes to buy new highs and sell new lows. Really. His system isn’t much more complicated than that.

Dennis’ Trading System

The system Dennis taught his turtles was simple. It revolves around trading 20 and 55 day highs and lows in liquid futures markets. The system had strict rules on position sizing, stop losses, entries, and exits, according to Dennis, if followed, would lead to riches.

Position sizing was based on the volatility and account size. Dennis and Eckhardt developed a concept called N, which would determine how many contracts to trade. This is how N is determined:

From there, entry rules were pretty simple. They would enter positions when the market price exceeded a single tick over the previous 20 or 55 day high or low. The only caveat is that in the 20-day trades, the trade wouldn’t be taken if the last breakout would have been successful.

Like I said, the system is quite simple. However, there’s some other details you should know if you’re really interested. A few former Turtles decided to put together a complete guide to the trading system and release it for free on the internet. You can find it here

Dennis’ Tools

Dennis’ system was so simplistic that he didn’t require that many tools to implement his strategy. 

Donchian Channels

Dennis probably didn’t use these himself, but they can be easily used to implement his strategy. They’re trading bands, like Bollinger Bands, that plot periodic highs and lows on a chart. See the chart below.

Average True Range

ATR is an indicator used by most active traders, so again, there’s no real secret sauce here. His system just worked. 

Dennis used a 20-period Average True Range smoothed with an exponential moving average (EMA).

Here’s the same chart with his ATR:

Linda Bradford Raschke

Linda Raschke

Raschke’s fame came from her interview with Jack Schwager in The New Market Wizards, and from her book with Larry Connors, Street Smarts, where the two go over several backtested trading setups. Raschke’s trading style is based completely on technical and sentiment analysis, she doesn’t pay attention to fundamentals or news. 

Raschke got her start in the early 1980s. Her job was across the street from the Pacific Coast Stock Exchange, so she’d get to work an hour early each day to hang out and watch the traders. Through her networking and passion for the markets, she was able to get someone to stake her with $25,000, a 50/50 deal. She eventually lost all of the stake, and another $30,000 on a takeover trade gone wrong. 

From there, she made steady money trading on the floor until she was involved in a serious horse-riding accident which left her unable to stand on the trading floor for extended periods of time. Through necessity, she had to adjust to trading off the floor, which she ended up strongly preferring. 

Most of Linda’s trading takes place in the futures market–the S&P E-minis in particular. To this day, she still day trades actively, but is ready to allow any position turn into a swing trade lasting several days. 

Linda doesn’t believe in longer term price forecasting. The shorter the time frame, the more conviction she puts in her forecast. A huge proponent of chaos theory, there are too many variables when you extend the time frame. 

Rather than pigeonholing herself as a “trend follower” or “mean reverter,” she changes her hat based on what the market is telling her. The way the market is acting that day will dictate the type of trade setups she looks for. She distinguishes each trading session by deciding if it’s a trend day or a consolidation day, and if the market is trading high to low, or low to high. 

Linda has run several funds, and her hedge fund was ranked 17th out of 4500 by BarclaysHedge in 2002 for the best five year performance.

Linda’s Favorite Tools

Linda utilizes several different tools in her trading– technical indicators, market internals, and breadth readings. She uses all of these in conjunction to find buying and selling opportunities. 

Here’s a list of a few of the tools she uses:

  • NYSE TICK
  • TRIN
  • NYSE Volume
  • 2 and 9 period RSI
  • 2 day Rate Of Change (ROC)
  • 5 and 10 day SMA of NYSE advance/decline ratio
  • Put/Call Ratio of S&P 500
  • 3/10 MACD oscillator
  • ADX (average directional index)

Linda’s Advice

Linda’s written two books and has been interviewed by just about everyone in the trading media, including Jack Schwager for The New Market Wizards, and Aaron Fifield on his excellent podcast, Chat With Traders. It’d be impossible to combine all of her advice in one section, but here’s two of my favorite nuggets of wisdom I’ve gotten from her:

My favorite exercise for novice traders is pick one market only. Without looking at an intraday chart, jot down the price every five minutes from the opening to the close. Do this for an entire week. Be in tune to the patterns. Where are the support and resistance levels? How does price act when it hits these levels? What happens during the last half-hour? How long does each intraday price move last? You won’t believe how much you can learn from this exercise.”

“Whenever you have your back up against the wall, you have to get smaller. Reduce your size to the level where you can start trading again, because in these types of situations when there is uncertainty or unprecedented volatility, there is lots of money to be made. But you can’t do it if you are frozen or stressed, so figure out the level where you can function and trade freely again.”

Ed Thorp

Thorp is one of the most versatile traders I’ve heard of. He’s managed to not only beat Wall Street, a sizable feat in itself, but Vegas too. Allow me to explain…

In the early 1960s, Thorp was a teaching assistant at MIT and became interested in the game of blackjack. He questioned the myth that winning systems were impossible at gambling games and began to run simulations on room-sized computers at MIT. He was able to develop a card counting system for blackjack that gave him a sizeable edge over the house, and won $11,000 on his first Vegas trip. 

From there, Thorp penned the card counting bible: Beat The Dealer and became infamous in Vegas casinos. Thorp claims that his car was tampered with to kill him, and that he was drugged while counting cards in mob-run casinos. 

After his fun with blackjack, he developed the first wearable computer to predict roulette spins. 

After figuring out that conventional wisdom regarding casino games was wrong: that they could be beaten, Thorp asked himself: ‘what else can I beat?’ and soon had the thought “The biggest game in the world is Wall Street. Why don’t I look at and learn about that?” Thorp viewed financial markets in the same way he did casinos: find an edge and advantage play it. All of his trading is based off statistics

Just five years after Beat The Dealer was published, Thorp came out with Beat The Market along with partner Sheen Kassouf. Many credit the book with starting a movement towards quantitative analysis in finance. 

Performance of trading strategy in Ed Thorp's Beat The Market

Chart of strategy’s performance in Beat the Market

The book detailed a warrant arbitrage trading system. In a nutshell, the system identified warrants and other securities that were overpriced relative to their underlying stock and went short the warrants while going long the underlying. These were essentially risk-free trades in an era of extreme market inefficiency.

Thorp’s first fund, Princeton Newport Partners, ran for 19 years and managed to have three down months in that time. For those counting, that’s 227 out of 230 months being profitable. Even more impressive is that the fund’s largest monthly drawdown was less than 1%.

Final Thoughts

Dennis, Raschke, and Thorp all had radically different ways of taking money out of the markets. Dennis was a strict rules-based trend follower, Raschke is a discretionary technical trader, while Thorp dismisses technical analysis as a whole and created statistical systems. 

The lesson here is that the image of a successful stock market practitioner to most is a long-term investor that tries to mirror Warren Buffett, and these three shattered that. 

Jack Schwager, author of Market Wizards, once said that “there are a million ways to money in the markets. The irony is that they are all very difficult to find,” so while becoming the next Linda Bradford Raschke won’t be simple, it’s very possible, all while treading your own path.072521049608