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ROBERT P. ROTELLA, ROTELLA CAPITAL MANAGEMENT - JUNE 2002
 
After starting his trading career on the Philadelphia Stock Exchange, Robert Rotella bought a seat on the New York Futures Exchange in 1985 and began trying to make a living trading his own capital

After starting his trading career on the Philadelphia Stock Exchange, Robert Rotella bought a seat on the New York Futures Exchange in 1985 and began trying to make a living trading his own capital. In 1986, Robert left the exchange floor trading his own account from his apartment. He also taught trading courses at New York University and the New York Institute of Finance and incorporated these courses and his trading experiences into a book, "The Elements of Successful Trading" published in 1992 (New York Institute of Finance). Organized along the three topics of trading methods, money management, and psychology, the book is a good primer for aspiring traders and presents the factors that underpin his trading approach. In 1990, he received an allocation from an outside investor (Commodities Corporation) with a $50,000 account and, after a few bumps at the start, went on to a highly successful career, making money in each of the next 11 years, trading interest rates, foreign exchange, stock indices and commodities. He moved to Singapore in 1994 to work for a joint venture between Commodities Corporation and ORIX Corporation. In 1996 he set up Rotella Capital Management, Inc. in Chicago. His first fund, Rotella Global Fund, was launched in September 1996 and in January 1998 he launched a more leveraged version, Rotella Polaris Fund. The Rotella Global Fund was discontinued in December 2001 in favor of the more popular higher leverage fund. Rotella Capital Management currently has $500+ million under management and employs 23 people. Robert Rotella spoke with HFN publisher, Antoine Bernheim, in June 2002.

Profile of Robert Rotella

Born: 1956 in Niagara Falls, NY
Education: B.S. in Chemical Engineering from Rensselaer Polytechnic Institute, 1978; MBA, Temple University, 1980
Family: Married
Last vacation: Scotland and Iceland in April and May 2002
Last book read: the Forgotten Soldier by Guy Sajer, Ubiquity by Mark Buchanan, Trading Systems That Work by Thomas Stridsman, and various photography books
Hobbies: travel, photography, reading, squash
Favorite quote: "God grant me the serenity to accept the things I cannot change, the courage to change the things I can, and the wisdom to know the difference."

Q. Could you describe your approach to macro investing?

A. We trade four different sectors: interest rates, foreign exchange, stock indices and commodities. We try to go with trends and use technical analysis to analyze the markets. Our approach is approximately 50% discretionary and 50% systematic. We trade the markets using systematic models such as moving averages and RSI with a discretionary overlay. We currently have 11 different models: some are short-term, holding positions for less than a month, some are intermediate (one to three months) and some are long-term (over three months). The basic idea is to look at historical price data, find various patterns that might occur in the markets, and analyze the results of those patterns: for example, if the market is up three days in a row, what is the probability that it will be up four days in a row or what will happen on the fourth day? The actual trading is fairly mechanical. Each model trades all the markets, and does so according to the same model parameters. In other words, the models trade currencies in the same way they trade stock index futures or interest rates.

Q. What factors are critical in determining that a trend is about to gain momentum or alternatively to reverse itself?

A. Generally, we have found it difficult and not too profitable to catch tops or bottoms or reversals in trends. When there is a transition from a bullish trend to a bearish trend, for example, our systems react differently depending upon the nature of the transition and the time frame of the trading model. For example some shorter-term systems might be going with the immediate trend, some intermediate systems might be out of the market and some long-term systems might still be in on the opposite side yielding a relatively flat position. I like to think about our trading as buying cheap straddles and strangles, which is more suited to markets that go from low to high volatility rather than trading highly volatile markets.

Q. Could you describe the ongoing research effort in your trading systems?

A. We do a lot of research. One third of our budget and people are devoted to research. Our models sometimes last a few years, but we might modify them once a year and sometimes every two to three months. The better we are doing, the less we would tweak or change our models and vice versa. We look at many different areas to improve our trading models, and we are also looking at trading new markets, such as individual stocks, including long/short and statistical arbitrage strategies. We will test some of those with our proprietary capital, as we are currently doing with stocks, but we have not yet traded these models with our investors' capital.

Q. Could you speak about trade execution and how you enter and exit positions?

A. We used to do a lot of trading with stop orders, probably as a result of my background as a short-term trader on the floor. Now, we use a lot more market orders to try to improve upon our slippage. Because of the time frame of our trading, we usually have a time window to enter the market and execution, while important, is not as critical with longer-term strategies as with shorter-term ones. We always have a stop that is in place as soon as we enter a trade. Our computer programs also generate our entry or exit signals, but we won't necessarily act immediately on them if we think we have a good chance of getting a better execution. However, we would definitely exit a trade within a certain time frame if we received an exit signal.

Q. Is there a typical duration of your trades?

A. Approximately one third of our trades are currently short-term, one third are intermediate and one third are long-term. Over a reasonable time frame, that split is actually typical. The way trades are apportioned is somewhat a function of the markets. Currently, the dollar is weaker so we have longer-term positions on in some currency markets such as the Euro and Yen. In the commodities sector where we are not seeing clear trends, we currently have more short-term positions on.

Q. When and how would you use discretion in your trading?

A. We use discretion in four different areas: 1) Sector allocation - how much to allocate among sectors; for example, what percentage do we allocate to interest rates versus currencies, stocks, or commodities; 2) Intra-sector allocation; how much to allocate within a sector: for example what percentage do we allocate to short-term interest rates versus long-term; 3) Overall leverage: we generally increase our leverage when we are doing better and de-lever in bad times; 4) Model changes: modification, creation, and deletion of trading models. We have determined that if we had just traded our models without discretion, we would get about a 1:1 return to drawdown ratio over time. Historically, we have achieved approximately 2:1, so we assume that the additional performance is due to the discretionary element, which is why we define our approach as 50% systematic and 50% discretionary from a value-added standpoint. I form my discretionary opinion partly through the theoretical work I do looking at different markets and how they trade under certain circumstances, and partly through a more subjective technical analysis, looking at long-term charts and seeing certain geometric patterns. An example of that is a couple of months ago, the long-term Euro/dollar chart looked coiled and it seemed that it was ready to move, so I decided to allocate a little bit more to the currencies. There is also somewhat of a fundamental component, looking at where the economy is which may make us feel more comfortable being in a particular position in various markets. However, we never have any pre-determined position as to where a particular market should be trading at a particular time.

Q. What are your risk management tools and what is your approach to cutting losses?

A. The ability to cut losses is one of the most important parts of trading. There are very few trades that are going to be immediately profitable and keep going your way and there is a reasonable chance that the majority of trades you put on are going to have a loss at some point of their life. So you have to give some room for your trades to work. We run a lot of simulations to have a sense of how much room markets need to develop into a profitable trade; if the markets need more room than they have exhibited in the past, then we start considering exiting positions. We look at drawdowns both in terms of duration and extent. We look at the individual trade level as well as at the portfolio level and there are certain levels at which we would reduce our leverage. We measure our leverage in terms of our margin-to-equity ratio, and it varies from 5% to 20%. Should we start getting into a 6% to 8% portfolio drawdown, we would start reducing that leverage, and we would do it more aggressively if our leverage was closer to the high of our historical range.

Q. Could you describe how you spend your time?

A. My role is leadership and research, and I spend most of my time on research; I tend not to be involved in the management of the company. I like to read and travel a lot. I am very interested in nature, evolution, and the human condition. I have an artistic side as well in music and photography. I think ideas from these disciplines can be transferred to the trading area. I love trading but also think it important to have a balanced life and other interests.

Q. Where would you like to take your firm in the future?

A. Quality is more important than quantity to me - performance is more important than money under management. We want to be a firm where there are a lot of creative ideas flowing and the environment is a good place to work. I want to keep growing but not at the expense of having a lot of extra stress and being unhappy. I think that we could get to a billion dollars in assets under management without any reduction of performance. After that, we would probably need other products coming on stream to handle additional capacity. u

 
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