Briarwood Capital Management is one of a handful of diversified trend following managers who not only survived 2012 but thrived, earning 10.54% in its diversified program and 23.34% in its 2X program.
Like other trend followers who performed well in 2012, Briarwood did it not so much on the trades it took but more on the trades it didn’t take. Briarwood co-founder Paul (Bucky) DeMarco calls it “trend following but with a twist.”
If their core trading system — which is made up of three separate trend following models, two medium-term and one long-term — generates 100 entry signals, they will only take 35 of them after their two proprietary filters eliminate 65% of those trades.
The filter works on two levels: System and risk management. On the system level, it looks at data, such as volume, and can eliminate a trade in the breakout model if there is not sufficient volume when the signal is triggered. It also reviews the quality of the signal and its chance of success.
The system filter knocks out 30% of its trading signals.
“When markets are choppy, then hopefully we will be on the sidelines more than our competitors who operate on taking every signal,” DeMarco says. “We tend to have non-correlated performance as a result, for better or worse. There are times that we may miss certain signals that become a trend; there are times we will be on the same side as the trend-followers.”
After 2008, Briarwood developed additional market specific filters that eliminate more signals and calibrate them based on risk and performance expectancy.
“If you were a trader in the 1970s you just went with every trend and made money. Now a lot of trends end abruptly with V tops and V bottoms; we always believed in the concept of selective trend-following,” says co-founder Fred Schutzman. “At the end of 2008 we developed the risk probability evaluator.”
Their risk management overlay has two parts: A probability evaluator and a drawdown manager that handles exits. The probability evaluator rates each signal based on how it performed in every market over the last year or so. Schutzman says there is a mean reversion element to it in that it would rate a signal lower in a market that has performed extremely well for them over recent signals.
“The probability evaluator basically rates each trade and tries to define it objectively, [decides] whether to take a signal or not and we can adjust the allocation,” DeMarco says. “We risk 20 basis points for each signal for each system but if the probability evaluator rates it very high then we can risk as much as 40 basis points on that particular trade. If the probability evaluator rates it average to lower but still warrants a signal, we can risk only 10 basis point on that trade.”
This helped, particularly in December when they earned more than half their profits in both programs. The probability filter rated their short yen and long Nikkei signals very high and they leveraged those trades. The also earned profits with the same short yen long Nikkei trade in the first quarter.
Their drawdown manager attempts to solve the problem of giving back profits in sharply trending markets. “The drawdown manager is there to take care of risk. It looks at each market, each individual model and the portfolio as a whole and determines to place stops more sensitively,” DeMarco says. “It is when markets trend and become parabolic or price falls exponentially in a short amount of time that trailing stops can’t catch up quickly enough, which leaves you with this large open trade equity risk for a V top or V bottom, which is the Achilles heel of all trend-followers.”
The probability evaluator tests every trade on a risk/reward basis. “In the old days we were more concerned with technical analysis, now we are looking for good quality trades,” Schutzman says.
He adds that 2012 was a perfect storm of sorts where their filters eliminated nearly all losing trades.
The Briarwood principals seem the original odd couple. DeMarco was a coffee trader who worked in the pits at the Coffee, Sugar and Cocoa Exchange, and Schutzman was an academic studying technical analysis. Their risk management overlay is illustrative of that dichotomy. As a trader DeMarco hates to leave any profits on the table, and as a technician, Schutzman wants to stick to the parameters of the models.
“What Freddy and I have been able to combine is the traders’ mentality to [take profits] but still keep that technical ‘let your profits run’ mindset,” DeMarco says.
In retrospect the pairing is not odd, but rather an essential mix of disciplines to create a successful program.