Sheldon Knight is a System Trading Guru

Futures Magazine

April 1998
Volume 27, Number 4
Page 98

Sheldon Knight: Patience as a virtue

Source: Futures Magazine, April 1998
Photograph by Linda Sue Scott

By Mark Etzkorn
Many traders dive boldly into the market headfirst, find the waters chilly and never return. Sheldon Knight, by comparison, spent the better part of a quarter century researching and testing before taking the trading plunge. But when he finally did, he made quite a splash.

Knight, 64, a successful engineer and president of his own consulting firm, K-Data in Sunnyvale, Calif., opened his first trading account in 1986 with $75,000. The account ballooned to more than $1 million in a year. He also doubled his account in 1989 and has traded successfully, on and off, ever since.

Knights system, which trades almost exclusively the S&P 500 and Treasury bond futures, sues volatility-adjusted breakout rules and a money management algorithm that adjusts trade size according to available equity. But his system is a long way from where he started.

In the 1960s, Knight tried developing trading strategies based on statistical communication theory, a branch of engineering he studied in graduate school. Knight though the discipline, which involves detecting weak, intelligent signals amid large amounts of noise - messages the Voyager spacecraft sends back to earth are a good example - "was basically the market trading problem."

Working in the aerospace industry, he used his access to large-scale computers to test his ideas. (Price data then was not readily available - Knight had to manually enter stock prices from The Wall Street Journal.) Unfortunately, he found the theories werent applicable to the markets.

However, he did learn a great deal about how markets behave. During the 1970s and 1980s, he attended trading seminars and read books, analyzing and testing approaches he encountered. He was unimpressed with most methods he saw.

"Probably 80$ of the stuff disseminated to the public is nonsense," he notes. "Id take ideas people were promoting, test them and find out that one in 10 actually performs as well as the author says it does."

However, Knight does credit one seminar speaker, Larry Williams, for introducing him to the volatility breakout concept that eventually became the basis of his system. (Knight, though, applied the technique differently than Williams.)

Knight stresses the significance of the second component of his trading approach. "I just cant emphasize enough the importance of money management," he says. "Its just as important, if not more so, than the algorithm you use to develop entry and exit signals." (See "Tips, Tricks & Tactics for Developing Trading Systems," Futures, January 1993, for more on Knights money management technique.)

Knight, contrary to current wisdom, shuns longer-term trading. His system trades four or five times a week. "Ive never found anything in longer-term approaches that makes as much money as you can with short-term approaches," he says.

Entry levels are determined by adding or subtracting a volatility-adjusted figure from the opening price. (Volatility is calculated with extreme high and low prices.) Knight doesnt use stops. "If you shouldnt be long, you ought to be short," he says. "All the testing Ive done indicates you make more money if youre in the market all the time - if you have a good system."

Knight has had rough spots. In 1991-92, he stopped trading for months after suffering a 65% drawdown using a modified version of his original system.

But his approach always has been aggressive. Even in 1986-87, Knight experienced 50% drawdowns but he kept trading because testing showed such losses were part of the system. "Drawdowns dont bother me," Knight says. "If you dont have 40% to 60% drawdowns every once in a while, youre not trading to make the most money."

However, tests had not prepared him for the 65% drawdown. But Knight was philosophical. The system was not flawed, as far as he was concerned; the environment simply had changed. "Thats just the way the markets were that year," he says matter-of-factly. "That same trading technique made a ton of money the following year, but, unfortunately, I wasnt trading it."

He only traded outside the T-bonds and the S&P 500 once, in 1991. "During the summer trading months [June, July, August], the tick data patterns in the soybeans looked exactly like the S&Ps," he says. "The rest of the year, beans behaved quite differently. It was like there were two different beans - winter and summer." His system exploited the price patterns for a $6,232 per contract profit.

For years Knight has tested various popular trading idea. His skepticism of seasonal methods led him to design the K-Data Timeline (see "Out Of Season," Futures, March 1997, and "Trading The Seasonal Timeline," Futures, April 1997), which emphasized day of week, the position of the day in the month, holidays and significant market days over calendar dates.

Semi-retired, Knight has scaled back his trading recently - although he continues to research - and he now is designing a drawdown-minimizing money management system for a trading advisor. Its a switch from his personal approach, but Knight appreciates the philosophical chasms separating private speculating and public money management. "If youre trading public money, it doesnt matter how much money you make, it only matters how much lose," he says.

Copyright (c) 1998, Futures Magazine

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