MarkBrown

Currently private trader.

Retired professional bond futures trader with independently audited average per annum return of 21.74%.

Trading 6,170 round turns per million per year.

As reviewed in "MAR" Managed Account Review publication.

Mechanical Bond Traders: Pioneering Success in Liquid Markets

In the world of finance, mechanical bond traders are carving out a niche for themselves in highly liquid markets. These traders rely on a system-driven approach, where trading decisions are made based on predefined algorithms and rules, rather than subjective judgment. This method is particularly well-suited to the government bond market, known for its high liquidity and volume.

The Essence of Mechanical Trading

Mechanical trading in the bond market hinges on the utilization of sophisticated algorithms. These systems analyze market data, recognize patterns, and execute trades based on specific criteria. The efficiency and speed of these systems are paramount, especially in a market where milliseconds can make a significant difference in trade outcomes.

Navigating Liquid Markets

The liquidity of government bond markets offers a fertile ground for mechanical traders. High liquidity implies a steady flow of buy and sell orders, allowing traders to execute large orders without significantly impacting the market price. This environment is ideal for the high-frequency trading models employed by mechanical traders.

Building a Solid Reputation

Establishing a reputation in this niche requires a blend of consistent performance, transparency, and technological advancement. Successful mechanical bond traders not only develop robust trading algorithms but also maintain a track record of resilience and adaptability in various market conditions. They must also ensure transparency in their operations, giving clients confidence in the integrity of their trading strategies.

Facing Challenges Head-On

Despite the advantages, mechanical bond trading in liquid markets is not without its challenges. The primary challenge is the continuous evolution of market dynamics, requiring constant adaptation and refinement of trading algorithms. Additionally, the competitive nature of these markets means that traders must continuously innovate to stay ahead.

Some trading programs boast histories that extend well beyond their reported timelines. For instance, a notable financial group utilizes a program that has been operational for over a decade, though its formal reporting history spans less than two and a half years. The program’s creator, Mark Brown, attributes this extensive history to their deep understanding and confidence in the system.

Formed in April 1998, this financial group focuses exclusively on Treasury bond futures and options contracts. Brown, who developed the trading program for Computer Investment Research Inc (CIR), plays a pivotal role in its success. CIR, which receives a portion of the incentive fees from this financial group, is managed by two principals, including Brown himself.

In their synergistic partnership, Brown is responsible for developing systems and managing trades. The other areas of the business, such as investor relations, are handled by different team members.

The proprietary trading system of the group combines a countertrend model with a trend-following model, with the former having a more significant influence on trade decisions, according to Brown. This program is designed to be highly adaptive, featuring switches that enable it to reverse positions to minimize losses and capitalize on market trends. For example, if a trade is negatively impacted by a shift in market direction, the program can pivot, buying into the trend to recoup losses before reverting to its original countertrend strategy.

Despite some exceptions, the group maintains a consistent presence in the markets, either long or short. A notable instance of deviation was in late December 1999, when the group temporarily exited the market due to external concerns about the Y2K bug. Their return was marked by the successful implementation of both external precautions and internal system enhancements.

Enhancing Trading Efficiency:

“We adhere to mechanical trading,” Brown explains. The program conducts hourly market monitoring, with typical positions lasting between three to five days. Utilizing nonlinear equations, the model recalibrates its risk/reward assessments hourly, striving to optimize trading decisions.

One of the main challenges in mechanical trading is managing slippage—the difference in price from when a trade is initiated to when it is executed. Brown emphasizes the goal of closely mirroring the model's signals with actual trade executions. The system also avoids overreacting to market fluctuations triggered by external events, such as Federal Reserve announcements, unless they align with the group’s rigorous statistical criteria for profitable trades.

Brown is steadfast in his approach: "Our task is to execute trades as accurately as possible, following the program's signals. We recognize that outperforming the model isn’t sustainable in the long term. It's crucial to trust the system, even if a position momentarily seems counterintuitive."

Although the systematic program used by the trading advisor has shown potential for success in various international bond markets, it currently focuses solely on the US bond market, particularly the 30-year bond. This choice is rooted in the market’s consistency, familiarity, and liquidity. However, expansion into international markets, like those in Japan, Germany, and Italy, is on the horizon, as these markets offer predictability and an opportunity for portfolio diversification.

The advisor, Mark Brown, acknowledges two main challenges in venturing into international trading for the Dallas-based firm. First is the practical issue of time zone differences. Trading in markets like Japan or Italy would require activity during unconventional hours. The second, more significant challenge, revolves around client familiarity and comfort. Currently, clients are more acquainted with the 30-year US Treasury Bond, making it a strategic choice for building trust and demonstrating the program's consistency.

Despite these challenges, Brown sees great potential in international markets. He aims to establish a track record of quick recovery from market downturns, ideally within 30 to 60 days. This approach was tested in early 1999 when the program faced significant declines but rebounded impressively in the following months.

The trading program's compounded annualized rate of return stands at an impressive 21.7%, outperforming the median of the MAR financial sub index. However, it also exhibits higher volatility, with an annual standard deviation of 54% and a Sharpe ratio of 0.3.

In terms of asset management, the firm saw a substantial increase in assets under management by the end of 1999, largely due to the acquisition of a significant individual client. Brown anticipates that as the firm builds its reputation, more clients of similar stature will onboard.

The firm positions itself as an integral part of an investor's portfolio, particularly complementing the managed futures allocation. While the trading advisor’s disclosure document cautions investors that Brown may take positions that are opposite or ahead of client positions, this is largely a strategy for testing strategies with personal funds before applying them to client investments.

In conclusion, mechanical bond traders in liquid markets are at the forefront of financial trading innovation. Their success hinges on their ability to harness technology, navigate the complexities of liquid markets, build a trustworthy reputation, and adapt swiftly to changing market conditions.