From the March 01, 2009 issue of Futures Magazine • Subscribe!

Dreiss: Surf’s up for profits

In a year that produced explosive returns for old line long-term trend followers, it is only right that we profile one of the method’s founding fathers. Edward (Bill) Dreiss got a job at a San Francisco think tank after graduating from the Massachusetts Institute of Technology and the Harvard Business School. It was the first step in an eclectic trading career that spans several decades and two continents.

“We were doing mathematical modeling mainly involving game theory,” Dreiss says of his first job. Dreiss was introduced to commodities by one of his colleagues and had access to computers to do his research. “Out of that I developed a trading system [and] started to trade a small amount of money.”

In 1973, Dreiss went to work for EF Hutton as a commodity broker and in 1975, he started Commodity Consultants, one of the first commodity trading advisors (CTAs).

In 1976, he split off from his partners and continued the CTA. The Commodity Futures Trading Commission (CFTC) hadn’t been formed until after he set up his CTA, which was grandfathered in once the CFTC began registering CTAs.

Dreiss’ systematic approach to trading in the mid-1970s was pretty unique and he managed approximately $20 million, which he estimates was about half of all money managed by commodity traders at the time.

Dreiss was a pioneer in the use of computers. “I had one of the first assembled PCs ever made. In 1976 I went to Albuquerque and bought an Altair,” he says, noting that Bill Gates wrote the operating system.

“It was a miracle for someone like me, who used computers because of my background, that an individual could actually own a computer. To actually have your own computer was an exciting and novel prospect,” Dreiss says. “The first thing I used it for was to get my client accounting under control and then we programmed it to put the system on it.”

By the early 1980s, Dreiss’ performance flattened out and he started losing clients. At the time, Dreiss began designing software and doing a lot of surfing. “[Surfing] was the main focus of my activities,” Dreiss says.

In the mid-1980s, Dreiss researched trading methods using fractal geometry based on the ideas of Benoît Mandelbrot. “That led to the development of the fractal wave algorithm (FWA), which is the basis of the system I have been using since 1991. The FWA has a way of decomposing price data into fractal patterns. It is an efficient way of extracting data.”

The system identifies turning points that are then used in a standard charting technique to identify support, resistance and trendlines. “From a conceptual point of view, it is a very simple system but the underlying technology is extremely difficult to program,” Dreiss says.

In 1988, Dreiss moved to Australia, where the waves were big and the waters warmer than in the Bay area. By 1991, his new research blossomed into another trading system so he formed another CTA and began marketing it.

By the mid-1990s, he was managing $46 million in the pattern recognition program, but after a flat period his assets dropped and, having earned enough over the years, he never made an effort to market it. In 2000, his wanderlust brought him to another surfing Mecca, Hawaii, where his CTA Dreiss Research Corporation is located. Though more complex than many systems, at its heart it is a long-term trend follower, which is borne out by his 2008 return of 101.85%. His compound annual return since 1991 is 18.59%.

His risk management strategy, like Dreiss himself, travels a different road. Dreiss believes that due to common trading methods, many markets, even those with no logical connection, have become correlated. “It creates a financial correlation where no fundamental correlation exists,” Dreiss says. Because of this, he has created an overlay based on his equity curve where he will decrease leverage across the board after a strong performance period and increase leverage after a big drawdown. “I have developed a system to try to change the leverage in a counter cyclical fashion,” he adds.

Dreiss’ system does not identify commonly known patterns, but the patterns it does identify are simple. “I am identifying what I call a zigzag and then a pattern of nested zigzags. You have a short-term trend, which is defined by a series of higher highs and higher lows, or lower highs and lower lows, and those trends combine to determine a medium-term trend, which again is a series of medium-term higher highs.”

Dreiss calls the zigzag “the most basic pattern that you can possibly identify,” which matches his philosophy of trading and life. “I have an affinity for making things as simple as possible. These elaborate systems with huge amounts of computer power and rooms full of PhDs is not something I am interested in. If you look at [my] performance, it is certainly comparable to other people who do things that are a lot more complicated, so I am not sure what that buys you.”

And the more complex systems don’t leave a lot of time for surfing. “Some people want that lifestyle where they work 80 hours a week and are constantly in the trenches. That is not anything that I was interested in.”

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