| Building On The Past
An Abstract Mathematician Reaps Returns
July 2002
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| A dichotomy emerges in conversations with Timothy Morge, founder of
Blackthorne Capital, Inc. He’s an abstract mathematician and former
economist—a theorist who sees beauty in the charts of various
commodities. Yet, he’s eminently practical: His goal is to make money
for his 95 investors. And if his index program’s performance to date is
any indication of alpha, Morge is meeting his objective and then some.
During his 25-year career, Morge has been a floor trader on the CME,a
cash forex trader, an institutional arbitrageur, an offshore fund
manager, a private speculator and a bibliophile. He opened Blackthorne
in July 1991, and launched his Lucida Combined Index Program in
September 1999. But his attraction to commodities dates back to his
teens when he accessed an extensive trading library, replete with
manuscripts of technical analysis circa 1930 through 1950, belonging to
a family friend. Later, while attending the University of Chicago, a
roommate’s father, who was a floor trader, presented the students with
a trading problem to be solved using a computer. Because computers were
then in their infancy, the time and programming the task consumed are
almost inconceivable today, he says: three or four days in the
mid-1970s versus five or 10 seconds today. Blackthorne’s current
program, though not directly descended from his student work, can trace
its origins from that period. Morge was—and continues to be—influenced
by Dr. Alan Andrews, Roger Babson and George Marechal, all doyens of
technical analysis’ golden age. | |
Isolating A Pattern
Once Morge began working, he was able to purchase old trading manuscripts and books, amassing, he estimates, a library that today includes some 10,000 items. During one estate sale, he acquired 150 boxes containing hand-drawn charts and correspondence between, among others, Andrews and Marechal. The debate between those two, as manifest in the letters, sent Morge on a mathematical investigation that ultimately shaped his current trading model. He sought a specific pattern, which was neither intuitive nor visually present in charts. “It was maddening at first,” says Morge. “But we did isolate it, and now describe it as a zero state, which means the market is in equilibrium. It’s the market’s next move out of that state that propels the model’s next move.” From that zero state, says Morge, the market will regain its energy. And at that point, he will go either long or short. The model generates entry levels for the upside and downside, as well as stoplosses and profit targets. This model, which is the basis of the index program, is constantly reexamined by Morge and his partner, Gary Fritz, because markets change, he says. “The markets today are much different than they were in 2000, for example. The difficult part is creating money management and risk reward rules that exploit the nonchanging zero state pattern in an everchanging market.” Blackthorne, with some $10.5 million under management, currently runs two programs. The first, the Lucida Combined Index Program, has some $7 million under management and is open to all investors. It trades only Nasdaq 100 and S&P 500 futures. The Financial Futures Program, with some $3.5 million under management, trades bonds and currencies (euro, Swiss franc, Japanese yen). Because it is still being tested, it is open only to qualified investors; however, Blackthorne plans to officially launch it for all investors in the near future. Blackthorne’s trading model is applied to both programs, although each has slightly different trading characteristics.
The index program is short term oriented, completing about 66% of its
trades the same day. “The Nasdaq is a vehicle in which the signals,
when they’re good, happen immediately,” says Morge. “In 2000, our
average winning Nasdaq trade was about six hours; now a 3% move takes a
full day. Nasdaq trades are still around one day, while S&P trades
average three-and-a-half days.” The Lucida program has a robust
compound annualized return of 39.3%, compared with 3.4% for the Zurich
stock subindex median. However, the program is down 7.9% through May,
whereas the median is up 4.1%. |
| During this first quarter, the program
suffered three consecutive monthly losses—the first time such a thing
had happened. Morge says the program ran into two problems: gaps in the
market and quiet periods. “In the first, we’d put on a position and a
gap would open on the other side—it would knock us out. Then the
position would move back the other way, and we didn’t have a way to
reenter at a good risk/reward level—we would miss the move.” In the
latter, he says, the market was “so quiet for protracted periods, that
it was difficult to distinguish between the quiet periods we sought and
general market quietness.” For those reasons, “we spent a lot of time
upgrading the model and adjusting the math,” he says. “We made a major
change, not in how we apply the patterns, but in the models’ ability to
measure the pattern more precisely.” Since then, there has been a
significant change in the signals. April and May were positive, and
June is estimated to be flat. | |
The Tolerance Test
Blackthorne never risks more than 3.2% of capital on any one position, says Morge. “We know the initial stop before we take the position, and we put both in the market simultaneously. Stops are never moved for the worse, always for the better; and as soon as possible we move to break even.” In general, Morge says, he tries not to go beyond an 11.0% decline, peak to trough. So far, his maximum decline is 11.2%, which compares favorably with the median’s 11.7%; he is, however, more than three times as volatile as the median. |
| “Investors say they’re in for the long haul and that a 15% drawdown is
not a problem, but when you approach 9% or 10%, that’s when the
investor’s real tolerance emerges. If we’re going to make 35% per year,
we’re going to have drawdowns greater than 11% occasionally. But the
fewer and the smaller they are, the less we’ll have to find out an
investor’s risk tolerance.” And for that reason, Morge says, he prefers
a wide investor base. “I have some large investors now, and I’m in some
big pools. I’ve lost 15 or 20 investors along the way, but I still have
my first 10.” Because of his performance, he says, many have suggested
that he bump up his minimum to $250,000 or $500,000 and lose the
smaller accounts. He resists. He sees no reason to close them, but he
also believes “all traders are created equal in the eyes of the market.” | |
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