Ed Seykota - a patriarch of computer trading.

It’s not a secret that Forex market has incredibly changed over the past few decades. Technological evolution changed trading for good, but few know the people who stand behind this progress. Have you ever heard of Ed Seykota, a lustrous trader who brought IT solutions to Forex trading? His returns on capital compares to those achieved by Warren Buffett, George Soros or William J. O’Neil. He is among the trading gods with no doubt.

Edward Arthur Seykota was born in 1946 in the Netherlands, but at an early age immigrated with his family to the United States. His father tried himself as a stock trader and eventually became the first trading mentor for his son.

Ed had his first trade at the age of five in Portland, OR. His father gave him a gold-colored medallion, a sales promotion trinket. He traded it to a neighbor kid for five magnifying lenses and felt as though he had participated in a rite of passage. He started early to get interested in technical analysis, too. By the time he was nine, he had a bedroom filled with old radios, test equipment and oscilloscopes. Ed liked to generate and display wave forms. Later, when he was 13, his father showed him how to buy stocks and explained that he should buy when the price broke out of the top of a box and to sell when it broke out of the bottom. And that's how Ed Seykota got started.

In 1969 he graduated from MIT with S.B. degrees in Electrical Engineering and Management. Once he read an article by technician Richard Donchian that intrigued him much. Donchian demonstrated how a diversified simple five- and 20-day moving average crossover system made а respectable rate of return. The idea of an automatic mechanical moneymaking machine fascinated Edward. So he bought some block time at a local computer service, spent his evenings punching up cards from The Wall Street Journal and began to reproduce Donchian's results. He tried varying the parameter sets and found that other combinations also worked. He also noticed that longer-term smoothing worked pretty well, while transaction costs seemed to chop up shorter-term systems. That’s how future trading guru got introduced to technical analysis.

Ed Seykota began his trading career in the 1970s, when he was hired by a major brokerage firm. It was there that Ed developed one of the first commercialized trading systems for managing money in the Futures market. Ed went in on weekends to use the IBM 360/65 accounting mainframe to run tests. He punched cards and ran batch jobs in FORTRAN 4. He managed to test four types of systems on about 50 different parameter sets on eight commodities going back a decade. It took him half a year.

Eventually, the management of the brokerage company packaged a product around his research. The problem was, his boss was unable to follow the system and his boss was more interested in souping up the system to generate more commissions. Ed told them that their best move was to make money for their customers. No sale! Not only that, his boss refused to give him 10% of the commissions generated from the system. That's why Ed decided to leave.

So at age 23, Ed Seykota went out on his own with about a half-dozen accounts in the $10,000-25,000 range. As of mid-1988, one of his client accounts—which was started with $5,000 was up over 250,000 percent on a cash-on-cash basis. If we normalize for withdrawals, the account would have been up several million percent. Those are truly staggering results. Keep in mind that those figures spanned more than a decade of trading, so this was not a fluke or some lucky win streak.

Ed Seykota is a huge believer in rules. Everything he does is based on strict trading rules he’s outlined for himself. It’s how he manages to stay calm even when things aren’t going his way.

Seykota’s five most cherished trading rules:

1. Cut losses

Protecting your capital is your primary job as a trader. Making money comes second. Embrace trading losses. That means accepting a loss the moment the market invalidates your trade idea.

If you make the mistake of hoping for the market to turn around in your favor, you’ve already lost. The best way to embrace trading losses is to have a plan. Combine that with small bets and you’ll be light-years ahead of other Forex traders.

2. Ride Winners

Trading isn’t about having a win rate of 70% or 80%. It comes down to how much you make when you’re right and how much you lose when you’re wrong.

There are no two successful market players that are the same. Each of them have a unique style and differing opinions about the markets, technicals vs. fundamentals, and even risk management. However, they all share one incredibly important rule. They all require an asymmetrical risk to reward ratio. That’s a fancy way of saying that the rewards must vastly outweigh the risks. And the only way to achieve asymmetrical returns is to ride your winners.

3. Keep Bets Small

One of the best ways to keep emotions at bay while trading is to keep bets small. If you risk too much on any one trade, fear and greed will surely find you.

Speculate with less than 10% of your liquid net worth. Risk less than 1% of your speculative account on a trade. This tends to keep the fluctuations in the trading account small, relative to net worth. Notice that his risk per trade should be less than 1% of account balance. This allows you to endure losing streaks without losing your account or your nerves.

However, Ed Seykota also defines a percentage of his liquid net worth. This includes cash and other assets that can be readily turned into cash. As his rule states, one’s only allowed to speculate (using personal trading account) with less than 10% of liquid net worth.

It is crucial, because it drives home the importance of trading with disposable income. In other words, risking money you don’t need for rent, utilities, groceries or other necessities.