When the Intercontinental Exchange (ICE) bought the New York Board of Trade in 2006, David Martin understood that his floor trading days were numbered and began to prepare for life as an electronic trader—and eventually as a money manager.
He was somewhat prepared because he was not a pure scalper, preferring to trade spreads in the softs complex over the previous 15 years. “I started working to change and adapt trading strategies that would work in electronic markets,” Martin says. “I had a trading system that I worked on since 1990. It is kind of like trying to repair your boat when you are out at sea.”
Martin began his trading career as an options market maker for Cooper Neff after graduating from the Wharton School of the University of Pennsylvania with a degree in Decision Sciences and Information Technology.
He was a rugby player in college and loved the intense competitive atmosphere of the trading floor. Before he gained much experience on the floor, he had mock trading sessions with fellow young, aggressive and smart trainees at Cooper Neff, which got pretty intense. They simulated trading in difficult and chaotic market environments, which helped prepare Martin for the real thing.
“We trained each other to trade. When we went into the actual pit we would dominate because we were so well-trained,” Martin says.
He clerked in the coffee, cocoa and sugar pits for a year before becoming a prop trader for the firm. It was not long before Martin leased a badge and began trading for himself.
He began trading futures in the softs complex and gravitated toward spreads. His training in options helped. “Options are a three-dimensional puzzle, so when you see a two-dimensional puzzle it is easier,” Martin says.
“Most of the guys on the floor trade front-month paper. There were some back-month orders and a lot of times they [were] very wide. No one paid much attention to them,” he says.
Martin saw this as an opportunity. “As an options spread trader and options market maker, I basically looked at forward contracts as if they were legs in an option spread and I would put the pieces together and say ‘he is bidding for May/July, he is bidding for July/Sept and this guy over here is offering May/Sept.’ I aligned the pieces and saw there is a trade here.”
That was the beginning of a strategy Martin trades to this day as part of Martin Fund LP. “As I got more involved in it I realized that the spreads were trading at levels that [provided opportunities to execute] butterflies in a certain range,” he says. “I started mapping those trades and those ratios and coming up with formulas supporting them. Then applied those formulas and they worked so I expanded on it.”
It is a complex combination of a systematic and discretionary approach using technical and fundamental inputs. “It is a discretionary application of a trading program that is systematic—meaning rules based—and quantitative, based on statistics. I have all the formulas and all the rules that I put in but it is not a black box. I do have my formulas but it does not produce orders. I enter my orders and the discretion is applied primarily in terms of easing into and out of entries and exits,” he says. “You derive a formula which is based on a number of inputs and some of those inputs necessarily have to be fundamental inputs and not just price- and volume-based values. Things like crop estimates, [and other fundamental inputs].”
His program has a butterfly strategy, an option strategy and a strategy for the Goldman roll. “We trade [the Goldman Roll] but not the historical way where guys sell the first three days of the month and buy back once Goldman rolls. We are entering that trade six months ahead of the roll. How do I know what the fund position is going to be six months from now? The answer is I don’t but there are ratios that I follow that lead me down the path that gets me to the right place.”
Like his strategies, Martin uses a systematic and discretionary combination for risk management.
“We have a lot of different stops. We have hard dollar stops, stops based on open interest, time stops and trailing stops if we are riding a winning trade,” he says, adding they use seven different types of stops.
His approach has worked in the 25 years he has traded on the floor and the screen and is producing strong returns for his funds, which now manage $73 million. The Martin Fund One, which also trades grains, launched in January 2013 and eared 86.1% for the year. It earned more than 200% in 2014 and is down 14.5% in 2015 through March.
Martin understands the quantitative side of trading but doesn’t forget the lessons he learned on the floor and doesn’t believe in following a system without question. There needs to be some art to the science. “Any trader with 10-plus years of experience and is still trading is a good money manager, and has discipline. I have been trading for 25 years and have saved all of my data. It is not something I back-tested, it is something I lived.