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

Vaca: Beating the markets

How does a Ph.D. in experimental particle physics segue from teaching and working at Fermilab’s national accelerator to futures trading? He has a life-changing opportunity thrust upon him.

For Francisco Vaca, chairman and chief executive officer of Vaca Capital Management LLC (VCM), that opportunity took the form of a cancelled project — the construction of Fermilab’s superconductor. Left with two choices, wait indefinitely to see if funding would come through for the massive project or change careers, he went for the career change.

It was 1996, and Vaca had traded on his own since 1993 (mostly equities using his parents’ money). He loved trading, and he’d already begun to research and develop trading systems, so when a friend handed him an ad from a local futures trading firm, Vaca moved quickly. Within a week, he left his position as a post-doctoral fellow at the University of Illinois at Chicago and accepted a research position with C&D Commodities, home of famed trader Richard Dennis. He spent the next five years researching and implementing systematic trading strategies for futures and equities markets for C&D and learning about the business of managing money.

What’s the most important thing Vaca learned from his experience with the legendary Dennis? “You can beat the market,” he says. “You’re not going to find God unless you believe God exists. That’s often the case when people come into trading. They don’t believe that they can beat the market, so they don’t recognize it when they stumble across a winning strategy. I saw this first hand.”

Vaca says the transition from physics to systematic quantitative trading was easy for him because he knew how to use the tools. He was accustomed to dealing with hundreds of computers and the gargantuan amounts of data they produce and he knew how to analyze data.

However, he doesn’t apply physics to his trading. “That would mean that one can model the market with known laws of physics. Mother nature is one thing, trading or the markets have a mind of their own,” Vaca says.

Vaca and fellow C&D alum Paul Rabar launched VCM in 2000. His trading program, the Vaca Global Diversified Program (VGDP) was introduced in 2004. It uses a quantitative, probability-based approach to trade over 65 global futures, forwards and cash markets across nine market sectors.

The program is 100% systematic and technical. It looks at price, volatility and correlations among markets. It blends 16 independent models, covering four distinct trading styles: 25% pattern recognition, 25% counter trend, 25% trend and 25% momentum with two time frames: 50% short-term (5-10 day average holding period) and 50% medium-term (30-50 day average). Vaca weights sectors and markets equally in terms of risk and uses risk management algorithms to govern position, market and sector exposure. Probability-based algorithms provide continuous risk management.

In 2008, VGDP returned 22.36% after a 28.60% return in 2007. But Vaca’s strategy struggled early on, experiencing minor losses in 2004 and 2006. The program completely missed the bull run in the metals markets in 2006. Understandably baffled, Vaca set out to determine why. After a three-month review, he discovered that his probability-based filter overlay was simply too tight. In an effort to capture only trades with the highest probability for success, he’d been screening out potentially profitable trades — a eureka moment for Vaca. Loosening his probability filter requirement was the last material change he’s made to his program. Not only did the change fix his problem, it generated more trades and produced a better overall risk/reward trading strategy.

The strong return in 2007 validated his 2006 adjustment, though it also was generally a better year for systematic traders.

More impressive than the raw numbers, is VGDP’s returns on a risk adjusted basis. “Do a risk/reward analysis from May 2006 forward and you’ll find VGDP is pretty much top tier.”

This “material” change has been in place for almost three years, and while Vaca may be happy with his system, he’s a scientist at heart, so he’s always researching, refining and looking for improvements. Minor tweaks get aggregated and incorporated into the program toward the end of the year. This way he avoids disturbing the strategies in the middle of positions.

Vaca is looking for more than just a good return, he sees risk as a non-linear combination of various factors, not all of them obvious, and he thinks one of the biggest challenges traders face is discovering the hidden risks in their systems.

Vaca may not be applying the laws of physics in his trading, but his knowledge surely comes in handy. He uses some 325 CPUs to constantly analyze and refine his trading strategies. He designed his massive computer room himself and insists on building everything in-house, so he can fix it, improve it or modify it. You see, with the right tools, he does believe he can beat the market.

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