The Derivative - The Life of a Discretionary Trader with Breakout Funds’ Aaron Larkin & Matt Laviolette

Episode Date: February 4, 2020

This fun conversation talks with two guys who have chosen a life of monitoring the markets on a near real-time basis, covering serious strategy components, as well as whether a Bulls game or trading Asian markets overnight is more fun for a trader in their 20s, trading Trump tweets, what ‘you can’t lose money’ actually means, Indiana Hoosier basketball, going from global war to blooming peace in 45 minutes,  and being a dinosaur Breakout Funds is one of the more unique strategies that we collaborate with as they focus on being a bit more discretionary, more short-term, and approach the market with more convexity than your average manager - sometimes leading to interrupted vacation time. Aaron Larkin, CEO & Co-Founder, and Matt Laviolette, Founder, CIO, & Principal of Breakout Funds join us on this episode to discuss their backgrounds and how their unique approach works. Follow along with the Breakout Fund team through LinkedIn with Aaron Larkin & Matt Laviolette and the Breakout Fund website.  And last but not least, don't forget to subscribe to The Derivative, and follow us on Facebook, Twitter, or LinkedIn, and sign-up for our blog digest. Disclaimer: This podcast is provided for informational purposes only and should not be relied upon as legal, business, or tax advice. All opinions expressed by podcast participants are solely their own opinions and do not necessarily reflect the opinions of RCM Alternatives, their affiliates, or companies featured. Due to industry regulations, participants on this podcast are instructed not to make specific trade recommendations, nor reference past or potential profits. And listeners are reminded that managed futures, commodity trading, and other alternative investments are complex and carry a risk of substantial losses. As such, they are not suitable for all investors. For more information, visit www.rcmalternatives.com/disclaimer

Thanks for listening to The Derivative. This podcast is provided for informational purposes only and should not be relied upon as legal, business, investment, or tax advice. All opinions expressed by podcast participants are solely their own opinions and do not necessarily reflect the opinions of RCM Alternatives, their affiliates, or companies featured. Due to industry regulations, participants on this podcast are instructed not to make specific trade recommendations nor reference past or potential profits, and listeners are reminded that managed futures, commodity trading, and other alternative investments are complex and carry a risk

of substantial losses. As such, they are not suitable for all investors. Welcome to The Derivative by RCM Alternatives, where we dive into what makes alternative investments go, analyze the strategies of unique hedge fund managers, and chat with interesting guests from across the investment world. Just waiting for a setup in the market where we can get in, in the style that we like to do, you know, high risk reward where we can get on, you know, chunky size with great upside with a small amount of risk. And that doesn't present itself every day.

And so we kind of look for that. Welcome podcast listeners to The Derivative by RCM Alternatives. I'm your host, Jeff Malek, and I'm pumped to have not one, but two fellow Chicagoans with me here today. We're sitting down with Matt Laviolette and Aaron Larkin, the co-founders of Breakout Funds. Breakout Funds is one of the more unique strategy types we've run through our due diligence process over the past year, being a bit more discretionary, a bit shorter term, and taking more of a convexity approach than most. So I'm excited to get in the nitty-gritty of what you guys are doing to make things go. Welcome, guys. Thanks for having us. Yeah, welcome. First, let's get into how you got here, get some context behind what you're

doing. So we'll start alphabetically. Aaron, give us a little background where you're from and how you got here. Yeah, so I'll go a little deep back here. I started off, you know, from grew up in Indianapolis, went to IU and when I was going to school I worked at a billboard company part-time and one of the owners at the billboard company, his son, was a partner at a trading firm in Chicago. So he made the introduction my sophomore year in school and came up and met with the trading firm. And as soon as I graduated three days later from college, I started working at the trading firm and been in Chicago since. What were they doing with the billboards? That was the most exciting part of that for me the uh you know there was about 500

signs uh across indiana and i was in charge of uh putting up the signs and taking them down so um i've in the old days they'd paint those on there now it's like canvas stretched yeah yeah it's much easier the the painted ones which we had a few of them were pretty heavy trying to put that out digital too yeah yep so that was uh that start and, uh, that's kind of what got me, got me into, uh, trading. Super quick sidebar. Can you, there's like a thousand Urlacher hair restore billboards around Chicago. Does that blow your mind? Yeah. Yeah. That would, uh, I guess that was a good job for somebody putting up, uh up all the signs. So we'll come back to you at the trading firm then.

Matt, how about you? Sure. So I also grew up in Indianapolis area. I did no errand down there. Went to Indiana University, graduated, and always knew I wanted to be in markets. Knew I wanted to be trading since high school, really. And it was just kind of like, where's the fit going to be out of college? Ended up going to Milwaukee, a place called Strong Capital, and working in their private

clients when I was the quote-unquote trader, which meant you sent a fax over saying buy some mutual funds, which was not really trading. But I did touch base with a few trading firms in Chicago while I was at school, and one of my friends ended up getting hired by one of them that I spoke with that ended up being where I left Milwaukee and came to Chicago to start prop trading in 2003. And that's where Aaron and I kind of joined forces in the prop world. And let's just, for any listeners that don't know, it's rather common knowledge in Chicago, but what is a prop firm? So proprietary trading means it's a firm that has its own capital and assigns risk to people like myself or you, and you trade. But we don't have client money.

We didn't have investors of any kind. It's just backed by the partner's capital. So essentially a hedge fund that's trading many of the same types of strategies but their own money instead of outside money. It's a small hedge fund. And, you know, we were all futures. There's various versions of this, you know, options guys and stuff like that, but we were always futures. So you're both alums of Indiana? Basketball fans?

Basketball fans, yes. Were they ever going to be back? They lost to Rutgers last night. They lost to Rutgers? Yeah. Oh, no. basketball fans basketball fans yes where are they ever going to be back we lost a ruckers last night so they lost a ruckers yeah oh no yeah no they're uh i don't know they're not they're not they're not worth uh worth my time right now who's the coach archie miller he's a good coach yeah got that going um cool so then you're both here in chic Chicago and ended up at the same prop firm? Right. Which one was that?

A firm named Black Diamond Futures at the time ended up becoming Black Diamond Capital. So Matt and I both spent about three years together at the firm, and then I kind of left and managed my own book, and Matt ended up becoming a partner for about seven years before moving on. It was interesting. At the prop firm, we started off working the European hours, which is typically the path whenever you come in at a prop firm. They put you at the overnight hours, and the markets are slower. You can kind of learn a little more price action, a little more order flow. And so Matt and I started off working at 2 a.m., worked into the U.S. Open.

We typically liquidate our positions on the Open, come back, work the close, and then we would sit around and work the Asian hours as well and then go home and try to sleep for four hours before coming back and doing it over again. What's that like for home life? There is no home life. You're 22 years old, and, you know, your job is to bang it out. You know, that was one thing. The first hurdle with hiring guys back then was can they do it?

Can they make money? And then it's can you do it and still, you know, get up at one 45 in the morning, come in every day, sleep a little bit during the morning, get back up, do it again over and over and over and over and still feel like a human on the weekends. And, uh, you know, I mean, it's just a different thing. And, and one thing I found with Aaron and I is we were always the ones just, we were just there know 24 hours a day really didn't you have any regrets like your buddies are going out doing whatever going to a bulls game or something and you're there at the trade desk yeah but it was also it was fun right i mean you know it's you don't care back then you don't have kids you

don't have family and it's you know the upside is you know kind of exciting um but you know it's it is what it's just what you did you didn't really you know we live in a little area we lived in lincoln park up there in chicago and had a little three block area i stayed in and never left and it is what it is it was kind of fun well let's see it's kind of funny i think that you're just wired that way i mean it was just the right fit there was it wasn't i felt like i never felt like i was missing out it was just i wanted to be sitting at my desk and learning from markets and learning how money flows around the globe and right they were missing out they were missing out so um yeah i mean the funny thing i remember thinking back then was when you know when you get up that early and your day's mostly over before people even get up to work and it's like a ghost town and you go to Starbucks at 5 a.m. when they open and you're walking around and people, when you're going home and you've done it, you know, you've had a good day and people are just getting up and you're like, what have you guys been doing?

You know? Yeah. Money never sleeps. The old Wall Street line, right? And talk just for a second how the prop firms actually work. So did you guys put in your capital? Not initially. So you get hired and they assign you risk.

Yeah. And, you know, when you start, especially back then, the risk is really small. And you have to be able to make money. And, you know, they would say, you know, the first six months, if you can just scratch and not lose money, the first job is to figure out how to not lose money. And they're like, you can lose $100,000. Oh, God, no.

If you'd allowed you to have been gone. So, I mean, when I left, for instance, when I left Strong in Milwaukee, my boss there was from Bear Stearns. And the way he found out that I was coming to trade in Chicago was not the best, but he was all for it because he knew that's what I wanted to do. But he said, you know, it's either going to work or not, and they're going to put you in a body bag real quick if it doesn't. And it's true.

I mean, we hired, you know, in my, my time there, I think I hired almost a hundred guys and, you know, we'd go through them quick and if they didn't work, they were out and you had to, you had to eat what you killed. And if you didn't make money, you were out including us. And, you know, that's a mindset we take to this day, right? I mean, you have to make money and we believe you have to make money. We're not trying to just beat the S&P if it's down or something. I mean, you know, we're of the mindset, like it's a day you should be profitable today. And constantly, right? So if you have five great years and one bad year, you're still out. And especially in a prop environment. Yeah. If you have five great years and you have a little bit of a drawdown and you start losing money, you're gone.

That's just no tolerance for it. It's tough. It's like NFL or something, right? Yeah, for sure. You've got to compete. You've got to win. And I think that that's what really teaches you how to adapt to changing markets. It's like your original strategy might work for a few years, and if it doesn't work, you've got to just throw it away and move on

because the market changes. And so the prop space, it probably takes it to the nth degree of adapt or get out. And that was really what you can walk away from that space is that markets are always changing. If you're not adapting, you're out. We would have guys, you know, back then in the early 2000s, there was markets were going through these cycles. I would call them like six weeks to three months type situations where markets would do certain things and you'd kind of figure out

the game and, and okay, like, you know, just for instance, they would rally between 6am and 8am or sell off between 2am and 4am. And you kind sell off between 2 a.m. and 4 a.m. And you kind of learn how to play that game. And the guys who were around that could make money, you know, after we filtered out the ones that can't, could pick up on that. The ones that made it for years and years and years and did well are the ones that realized when, okay, this doesn't work anymore. The first day you lose money doing that, forget it. It's out of your mind. It never happened.

Try and figure out the new game the next day. But we would have guys make three months of money and give it all up in the course of a couple days because the market's changed. And you have to be able to change with the markets immediately. Last week is a great example. You know, we went from global possible war to booming peacetime in 45 minutes. And, I mean, you know, we're on the high tick right now for S&Ps. And, you know, our job and what we talked about immediately after that event was it never happened. Forget it.

You know, obviously it's in your mind if something else happens, like you go right back to that. immediately after that event was it never happened. Forget it. Obviously, it's in your mind. If something else happens, you go right back to that. But it never happens. It's my son's little league coach. Whenever he has a bad place, flush it. Yeah, forget it. You have to have a short memory.

We'll get back to the strategy in a minute. So you're at these prop firms, a few of the Chicago ones have pivoted or evolved into, excuse me, into high frequency trading firms. Were you guys on that edge? Did you ever get tempted by that or how did that look? Yeah, Black Diamond, you know, in my time there, I was there until about 2010. I was a partner for most of those years. We never made that transition for whatever reason. We were just always, you know, we always, even back then we had called ourselves dinosaurs, that we were just humans pointing and clicking and trading. And, you know, there was, what's that? What dinosaur? Yeah. But there was. Velociraptors, hopefully. Yeah. I mean, there was a lot of firms that made that pivot to HFT, and that's really expensive. And they made a lot of money for a little while, and then they get killed.

You know, I think, but forcing ourselves to do it the way we did it, we learned how, you know, price action actually works, and how to make the decisions ourselves and how to trade ourselves and execute and day over day risk versus letting a machine do it and when the game with the machine stops working what are you going to do? That's an interesting point right?

If you spend all these hundreds of millions of dollars or tens of millions building out your high frequency infrastructure and the game changes you're toast what do you do? Start Netflix. high frequency infrastructure and the game changes you're toast what do you do yeah yeah start netflix okay you're listening to the derivative i'm jeff malik and we're back with matt and aaron from breakout funds so guys you're going down to context In Miami, I don't think there's much of an elevator ride, but you're in the elevator. You're talking to an allocator or a high net worth guy.

Give them the elevator pitch. Well, I think I would probably start off first that we're a global macro discretionary fund. We approach the markets from opportunistic, which we bring our prop trading skill set into this macro view. We kind of started at the 30,000 foot level with this macro view of what we expect to happen, what we think is going to play out over the next three to six months. And then from there, we drill down in time. So when we look to put on risk, we look for one, we look for market structure. And then second, we look for a catalyst. And so what we've learned is that you need the market structure once you can define what your risk is.

As we kind of talked about before about the prop space, meaning if you lose money, you're out. You learn to risk is first. Controlling risk is job number one. And then job number two, of course, is looking to make money. And so for us, it's always control risk first and then use the market structure, and then we use a catalyst to express our opinions. So what we've learned over our career is that opportunities present themselves in one to three to two weeks at a time. And so what we try to focus on is identifying when those catalysts or those events take place and then to take our macro views and then to implement risk at that time.

So if I shorten it to a one-floor pitch, we're event-driven professional traders? Yeah, I think that's a fair way to put it. We're opportunistic, absolute return, discretionary. So let's dive into the discretionary a little bit because that makes some people nervous i've long argued with some family and friends up in wisconsin like how do you you're having this guy in waukesha wisconsin manage your money how do you think he's the best guy in the world to do that so it's kind of how do you guys think you know more than the desk at citadel or goldman's trade desk or something where you can get out in front of a trade before they do, or does it not matter?

Yeah, I think it does matter. I don't think those guys have come up on the background that we have, like what we were saying earlier where you have to survive every day, every month, month over month, let alone years. And you have to be able to trade. And I don't know necessarily that when you come from a big institution like that all the way up, and now you're running a few hundred million dollar book or a billion dollar book at a Citadel or something, you haven't lived through the knife fight of actually executing markets and trading in that manner like we have. But, I mean, we have definitely – that's a hurdle, right, for us on a discretionary basis.

I mean, you know, there's a place where I play golf in Chicago. It has a lot of ex-itt traders in it that belong there. And they always say... No, Beverly. And they would say, what's your edge? And the answer is, I'm right. And that's just not a believable thing to say, really. But the answer is, we're right more than we're wrong.

And we just have to prove that. And, you know, so we try and keep the communication up with people we're talking to and what we think about things. And as it plays out, you know, the trust builds up and then it's, you know. But is that true? Do you try and be right more than you're wrong or just when you're right, you're right more than that you lose when you're wrong? You know what I'm saying? Like is your winning percentage actually very high? Or is it just when you win, you win way more than you lose on all the losers?

Our actual winning percentage is less than, you know, it's probably around 40%, I'd say. Okay. Right. So it's not that. But our winners are, you know, vastly outsized of our losers. Got it. So it's asymmetric setups where I don't need to be right.

I just need to, when I'm right, I need to be very right. Yeah, I mean, we're very good at adding to positions aggressively and taking them off aggressively. And so it's kind of getting in the weeds a little bit. But when we sort of formed this company, one of the main philosophies was, and if you look back at all of our years of prop trading, the returns are always lumpy. So there's two to five great setups or opportunities, whether that's a day or a couple week period throughout a year to make your money. Where markets are going to move, there's opportunity to put risk out there when

you should be putting risk out there, which is not just every day. And then there's other times you just kind of push the ball forward or just try and go, we revert back to what we learned where let's not lose money and just kind of make little crumbs here and there, little base hits if you can. And that's fine. And you're just waiting for the next setup. And if you're doing that, and if you can stick to that, where you're only looking for these great opportunities and put risk out there, then you're going to do really well. So therefore, you always have to be engaged in the market. So that lends itself to being in trades and out of trades. So that's going to take our winning percentage down.

But when we do have those pockets, you know, the upside is there. And speak to that just for a second, because you can say, you know, don't want to lose money, but nobody wants to lose money. So how do you make sure that happens? But when you say that we don't want to lose money is I'm getting out of trades quicker. I have tighter stops. I'm Yeah, you just like one of the main lessons of you know, the team the tooth out like 2013 to you know the QE days was You know You just had to figure out how to not trade

right, I mean you might have a little you know, some sort of risk out there, but There's a lot of times during the day, just don't do anything, you know, just, and it's a, that was a skill that took a lot. That took a long time to figure out. Better part of valor is discretion is the old, is the line, I think. Yeah. And, and just recognizing when it's time to do nothing and being okay with that. You know, we have some quantitative stuff that backs us up now that kind of we've proved that to ourselves of what we like to use as signals in the market and what we thought were great trades

throughout our career. And they all prove the same thing. They all happen a few times a year as when you should be doing them. And so we're going to be super aggressive when those situations are there, and then we're not going to be doing much. And so let's dive into that a little bit more. Aaron, the systematic setups or the systematic informs the discretionary? How does the systematic part come in?

The systematic informs the discretionary? How does the systematic part come in? The systematic informs the discretionary. So we kind of, as we call it, we have a discussion amongst us on what we were looking to do. And so the systematic signals typically come in at 5 p.m. at night and we'll get the potential signals for the following day. And that comes into the portfolio discussion. And so we take the systematic signals and their votes. We take our outside research, and those are votes. And we take the market theme that's taking place right now, and those are votes. And then in our portfolio discussion is where we decide where we want to express risk or if we want to express risk.

A lot of times maybe the systematic signals might be contradicting what our discretionary or some of our other research is saying. And that's typically a good time to say sit on your hands and wait for clarity. And so they're informative. Their votes, they help. And what do those look like? They're saying go long crude oil at this price or it's just a directional? Matt and I trade. We always have a stop, you know, in place. And then we also have an idea roughly where we think the market's going to go. And that's what we're looking for.

But part of that also comes with listening to the market. You take what the market gives you. And so let's walk through a theoretical theme, setup, systematic signal, the whole thing. That's an example. Yeah. I mean, to back up two seconds, you know, we may have an opinion on the market, and we don't just get into it, right? We do all what Aaron just said.

The opinion may last six months. So, for instance, last year, right about this time, maybe a little bit later, we started getting really bullish on gold. But we didn't put it on for probably three weeks because we were just waiting for a setup in the market where we can get in in the style that we like to do, you know, high-risk reward, where we can get on, you know, chunky size with a great upside with a small amount of risk.

And that doesn't present itself every day. And so we kind of look for that. It's actually high reward risk. Yeah, right. People say high risk reward, but. Yeah, and if you happen to be wrong, you know, it doesn't hurt too bad, right? And then you can do it again if it sets up again. And what does that look like for you?

It doesn't hurt too bad. So we may have this opinion or. Like a 1% loss or a half a percent loss. Probably about 25 bps, 25 to 40 bps depending on – we kind of look at it in three tranches. So the first tranche is 25 to 40 bps depending on market setup and then another 25 or 40 and another 25 or 40 to add as price confirms. So when we put on something, we expect to be right right now. Like the market is moving right now.

And if it doesn't we're getting out and that's just it um and we'll add we'll add aggressively if we're being proven right and you know the stop get adjusted and the risk stays the same so not you know obviously um that's how returns can compound pretty quickly um in short amount of time you know we think that and we've proven it through our testing and everything, that the first one to three days of the trade are kind of where you're going to make your money. And you may be dead right on the next four weeks

of that position, but you've got to catch it when the market turns, when nobody's looking. That's when the aggressive move happens. And we kind of want to be a part of that. And then we want to take it off the table. We may hold a core position for a longer period of time, you know, could be weeks or, you know, 10 days. But the kind of the chunk of the returns is those first few days. And that's kind of what we want to be a part of. So I got a new elevator pitch for your millennial traders. You need instant gratification. That's right. So we got sidetracked there. So give me another theoretical setup that was sort of around there. So in equity land, you know, if we were to have

an opinion on a risk off or risk on basis, The way it would work is we would be forming that opinion over time. For instance, if we think, as of right now, markets are racing higher. Usually, equities are the last thing to react if something changes. You'll see it in currencies. You'll see it in bonds.

You'll see it somewhere else before that. And equities will still push higher, and people will lose money. And during those times that things turn is kind of where you put that in the back of your head and be like, okay, you know, we need to be ready to be short if XYZ happens. And XYZ may or may not occur, but we'll use our indicators at night and kind of it all, their votes, as Aaron was saying. And, you know, when those all line up as aaron was saying and you know when those all

line up we'll we'll get in you know if the structure is there we're happy to miss trades too right i mean if it's not there where we think we can define the risk we just you know we'll miss it that's fine and what does that look like if the range is too big you don't you think yeah i mean it's a you know the best trades entry are low volatility to high volatility expansion. No one's paying attention. Everyone's positioned one way. We pay a lot of attention to what big funds are doing. Are they all long something or short something?

Are they going to get caught with their pants down if something turns? That's what you want to see. So a lot of what you're doing is kind of game theory, right? You don't need to just have your own opinion, but you need to know what the other players are doing. That's mostly what I care about. Okay. It's psychology of what is everybody else doing?

What are they thinking? What makes them, where's their pain? Where are they going to get, where are they happy at? You know what I mean? That's the game. Study game theory and behavioral finance, or is it more just your experience of being in the trenches? That's just what you know.

I mean, it's just what you kind of figure out. You know, in the financial crisis, you could see it. I mean, it's almost like colors on a screen where people are freaking out, and then some days they're not, and intraday it changes and shifts back and forth. And it was the best learning you could do. And again, we don't see markets like that all the time, but we see pockets of them. We see pockets of it for two hours at a time, and you have to be ready for it. What are your thoughts?

It can be argued that with algorithmic execution like iceberg orders that's a simplistic example of like people can better hide their intentions these days what are your thoughts on that i think that adjustment for us came years back. I mean, we had to adjust to before, you know, before the whole HFT took off, you could tell a little bit more about people's positioning and what they're doing and the price action that's taking place. When HFT took place and got big in the markets, it was noisy. You couldn't really tell as clear in the short term maybe what price action is doing, but you could still identify when, as we would say, paper would come into the market and do

something. So I think people still show their hand when they need to really move something. And so we're still able to recognize when there's actual. Yeah, if order flow is real, it's real. And, you know, when people are trying to play a game, you know, we've seen before, you know, everybody cracked down on spoofing, you know, early to mid-2000s, there was, you know, that was a full-time job for a lot of people with, you know, the crazy crap that was going on there was unbelievable.

And you're saying you're more into what actually gets reflected in the price versus the offers and bid that may not even be real. Yeah. I mean, these markets are actually, from what everybody's going to say, I mean, they're pretty thin. Way more thin than they were back then. So, I mean, good luck if you're going to put some, you know, some stuff in the market like that and you don't really want it, you're probably going to get it. Yeah. I don't think paying attention to the bid and ask, I assume it's all fake. I assume everything's fake now and it's actual execution and price movement. And is the real volume behind that move is where you get the confirmation. And on a daily, weekly, monthly basis too, some of your models, right?

And your main themes are all the way back into that timeframe. Yeah, yeah. So our models are designed on daily bars, and they're kind of incorporating a little bit of everything into that. It's hard to fake a month-long 10% up move in gold. Yeah. Openings and closing prices are the most important. What happens in the middle of that is, for the most part, noise.

And it kind of goes into our view of everything, what Aaron was saying earlier, 100,000 feet. Everything we look at is from 100,000 feet to start there and drill down into the minutia of intraday. I'd go more like 100,000 seems super high. Okay. 15 feet, I don't know. 30,000. So just touching back on the big players, they're coming in,

you see the markets move. Do you have actual process for identifying and knowing who those players are, or it's just that reflection on the price? Well, it's funny. So, you know, back in our Black Diamond days, I mean, we used to see trader IDs. We knew who was on the other side. So we knew that if 353-OK-Y comes in, you know, that 353 was was goldman sachs's badge or their tag and they had three traders it's but during the overnight hours there's three main traders x y and z or whatever it was and you know one of them was definitely the junior trader that you could

you know you could fight this guy the other guy was you know sometimes he meant business and sometimes he didn't. And the third one was like, if you're on the other side of his trade, get out. He's not stopping. So, and you kind of learned how people in UBS had, you know, an S&P 10 lot buyer or seller. He would come in and he's going to be buying these 10 lots for the next eight hours and he's not stopping. Yeah. And these are things you learned, and you can see it. And now they took away the trader IDs, I think, in 06,

which we all thought we were out of business because we weren't going to see it. But actually it turned out they don't know me from Goldman Sachs now, right? Right. And so it was a huge advantage, which you didn't think so. But you can see in the market what people are doing. You can recognize someone who means business, what they're going to be doing, versus someone who kind of has a weak hand. And our quant team that builds our execution algos,

they've actually told stories of some of these high-frequency firms build profiles. Absolutely. Yeah, so there's no more IDs, but they have an internal ID. And they see that 10-lot come in. They know there's 80 or 8 hours of 10 lots behind it, which is pretty crazy. So the research process. So you have a weekly meeting to hash out these themes, or it's just chatting back and forth. How does it work, both from the theme level and then the systematic level?

Are those models set and forget it? Are those constantly evolving? No, so there's kind of three parts to that question. We've got a quant researcher who does research for us. Matt and I will ping him ideas. He'll go do the research. He'll come back. We'll look at it, and we'll say that's either correct or incorrect or that's what we were thinking.

Typically it means we've got to go back, and that's the process and that's always in development we always have ideas you're always looking for ideas because markets are always changing so um so that's the the quant piece and then as we've mentioned we get signals that that are potential signals for the following day that we get on a daily basis and that's a piece that Matt and I will discuss typically somewhere between 5 and 8 p.m. at night. Still today, he'll typically find Matt and I sitting at our desk in the evenings because that's just kind of the way we're wired now. And so a lot of our communication takes place a lot at that time of what we're looking for to happen the next day, the next three days, the next couple of weeks. And so there's always kind of an open communication between Matt and I

on what we're looking for, what we're expecting and what we see potential development. And then we are always monitoring on a daily basis on, okay, this is actually happening. This setup is taking place. This looks like a good risk reward to implement risk on. And so I say it's on a daily basis, a weekly basis, and it's an open communication. It has to be. Markets are always changing. So do you ever get to go on vacation?

That's a touchy subject. It's tough the the vacation uh if the markets are open the markets come to vacation and uh that's uh that's an interesting subject you're not 22 and no family anymore right so yeah uh we do have lots of kids between the two of us and uh how many he's got four and i've got three all right congrats he's doing a better job he's got he's got triplets triplet girls it's a lot of a couple package deals it was yeah yeah i know a guy two sets of triplets two years apart oh my god yeah and buy like a sprinter van and change their whole life oh my god i don't know how they did it. No.

Yeah. So let's a little go into the markets a little bit, just general, not to give away your next trade or anything, but generally speaking, what are the main themes you're looking at for 2020? You know, we put in our outlet possibility for negative interest rates. Volatility seems artificially suppressed again. Yeah, I mean, I think after the, you know, we saw a big shift from, you know, last year we had all this volatility, this trade war stuff, and what's going to happen? Are we going to, you know, who knows how far down the rabbit hole we're going with China and all this stuff. And when they had finally the deal in October after we had some crazy nights there where, you know, is the vice premier going home or is he not?

Is he meeting with Trump? Is he not? Anyway, once that agreement took place, everything shifted. I mean, you saw that's one risk been going on ever since. We finally got some clarity out of the Fed where he, you know, told us what was going to happen and he's not going to go back and forth. And I mean, you imagine the last, you know, in the 12 months preceding that, he went from hiking and saying, we're not going to stop at neutral to completely reversing and doing a fake QE. Well, it's a real QE, but he's not calling it QE now and saying, we're not going to move for at least a year.

So the policy is whatever the policy is. We don't really care about that, but we want a clear vision of what's going to happen. I think that's what you're seeing in markets. That's why this rally is taking place. A, they're pumping money again. But B, we know what the deal is. We've got a trade agreement. It's good or bad. Who knows? Who cares, really? It's just we know it's done. And so you saw positioning into the year end where people were chasing, people had to put risk on. They were caught short because they thought maybe this wasn't going to work out with the trade agreement.

And then you get a chase into the year end because it's, you know, that's what people do, unfortunately, I guess, is, you know, you got to show you're long. You can't be left in the dust into the year end. And now the year's January. Except for last year, or 18. Yeah, yeah. And, but, so I think with that, you've got two groups of people. A, people are just trying to be a part of it, and people that really think, like, growth is coming back here. Growth is accelerating. You know, we try and really be aware of everything and be as knowledgeable as we can about everything,

but also forget it as quickly as possible. Because thinking you're smarter than the market is never going to work. You're never going to get carried out on this cross or that cross. I care if a certain group of people is bullish and why they're bullish, and I care if a certain group of people are bearish and why they're bearish. And I let the market tell me if who's right and who's wrong. And then I figure out where I can take advantage of them that way. But going into this year, either growth is going to come back or it's not. And if it doesn't, then March, April, May, we could see a serious shift the other way. But if it does, this could be a ripping bull market. And, you know, we were actually talking

before we came on here that that's, we've always, you know, one thing we talk about to, you know, whoever we're talking with is, you know, we've seen it all. We've seen slow markets, financial crisis, we've seen QE, we've seen, you know, bombings, we've traded it all. We've not traded a ripping bull market. And so that's something new and we'll be adapting in real time for sure. I would argue 2020 was pretty ripping bull market. I'm talking like tech bubble bull market. Like 100 and some percent over 18 months. It just keeps going and going. And, you know, we'll see possibly rising volatility

with a rally in equities, which we've not seen. Yeah. Right. So if you have a VIX living at 18 or 20 and market's going higher, so you might have, you know, one and 2% up days on no news, followed by, you know, 3% down days

and then a 4% up day. You know, that's stuff that we – Right. We've kind of the last eight years has been three steps forward, two steps back. Yeah. You're saying we're like eight steps forward, four steps back? Yeah. And not necessarily, you know, with a warning ahead of it.

Yeah. You know, these days the markets are moved on tweets and whatever else that moves these things. And how many risk-off events that we had over the last, you know, 12 months that were reversed out within hours based on a, you know, speculation tweet. It's crazy. I mean, but, you know, that's what moves the markets. And you have to be able to, you know, one of the big changes that I had to make this last year was, you know, last week, the Iran thing, where, you know, they attacked us in Baghdad. You know, Trump's made it very clear what the consequences are going to be of that.

Markets are down 50 handles between, you know, 5 p.m. and 7 p.m. at night. And you've got to take that money. You know, you can be a part of it. You know, we're very good at being on these types of moves, but you've got to take that money because can a tweet solve world war? It just did. I mean, like it just does, right? I mean, what are the does, right? I mean. What are the odds?

Markets come back. Sort of off topic. What are the odds someone in the Trump circles putting on a position before those tweets go out? Who knows? Greater than zero. And or that China puts on some huge, right? They're like buying a couple billion worth of E-minis and then saying, yeah, we signed the deal. I think that was definitely happening last year on their side. I mean, you could see, we were seeing into the close during the summer.

Order flow. Some bizarre major order flow. And then you'd get it. There's some sort of leaked thing at night where, you know, markets go one way, the other 20 handles. And you're like, oh, well. Yeah. Okay. I don't even know if that's illegal, right? where, you know, markets go one way, the other 20 handles, and you're like, oh, well, okay. I don't even know if that's illegal, right? They're just saying, hey, we're brilliant.

We built up our country's reserves by faking out the news. So will you ever trade off the tweet itself? Well, you have to react. I mean, you have, you know, whatever position we have on at the time, I mean, markets move on that, and you have to react. I mean, you can't decide if you care or not, if it's real or not. Markets are moving. It is what it is. That's the land of AI and, right, tweet reading,

AI that's automatically reacting. So it's tough to play that game, it would seem, in terms of speed to market. Yeah. I mean, sometimes you just try and not, if you don't have a position on and it's, you know, A, if it's helpful, just take it and wait for things to reset. Because you do see a lot of these algos reacting to reading news headlines and stuff. And, you know, yesterday, when, or two days ago, we had, you know, a 10 handle sell off in the middle of the day on some crazy headline about, you know, this trade deal, just details on it. And Algos just blasted this S&P's 10 handles. And it was right back within four minutes. Yeah.

So, I mean, those are situations where you just got to be smarter than that. It seems some of those that were in the press a couple years ago, that was the last you heard of them, right? Like this AI tweet-fueled hedge fund is going to change the world. Where'd they go? The market adapts. The market adapts to the tweets. I mean, you learn to ignore a majority of it or try to ignore a majority of it,

and some of it matters. And so if you have exposure out there, you have to decide whether or not this one matters or it doesn't matter. Right. You're not going to get carried out in your body bag, as you said, because you were like, this is dumb. I'm not paying attention to tweets. If the market's paying attention, you're paying attention.

If the market moves and you lose money, back in those days where you were referring to the property for it and you know that's it yeah they don't care there's no why you lost yes but yeah yeah all right we're back once again with the co-founders of breakout funds it's time to do favorites i'm going to rifle through some categories here, and you guys can jump in, alternate, both answer, whatever you want. Tell me your favorite. So let's do it.

Favorite Chicago pizza place? Pequot's. It's tough. I'm not a Chicago pizza guy, but my son likes coal fire. I'll do coal fire. I've got to second the Pequod's. That's the best. Pequod's.

By far. Caramelized cheese on the crust. And Pequod's eating it there, not delivered. Oh, yeah, yeah, yeah. It's a big difference between the two. A guy who worked on our trade desk ages ago, like 20 years ago at an old firm. He was their first delivery guy. Wow.

Which I don't know what he's doing these days, but he had that going for him. And then he became a trader. Yeah. Favorite Star Wars character? Chewbacca? All right. Yeah. Can you do a Chewbacca? Ooh, I don't think I got Chewbacca? All right. Yeah. Can you do a Chewbacca?

Ooh, I don't think I've got Chewbacca. Investing book. Reminiscence of a Stock Operator. That is the best one, and it's not close. Jesse Livermore? Yep. Yeah. I'm trying to hunt down.

I second that one. Non-investing book. Red Notice. Red Notice. Red Notice. Okay. Podcast. Do you guys do podcasts besides being on this one? I listen to quite a few.

I've been listening to mountain climbing podcasts recently for whatever reason. Do you do a lot of climbing? I did once a couple weeks ago. All right. Did you see that free solo documentary? I did, yeah. Unbelievable. Yeah, I know.

I was like, I watched it on the plane. I was like shaking. This, I don't know if this is applicable since you can't take vacations, but Lake Country, you're Michigan people or Wisconsin people? Indiana. Indiana. Yeah, we go to Lake Wabasee, which is in Syracuse, Indiana. All right.

It's about, I shouldn't be saying this because no one really knows about it, but it's awesome. It's only two hours away. All right. We'll trade notes on that. We're looking for a new lake. Yeah, I'm a Park City, I'm a mountains person, so. There you go.

Have you, real quick, on Indiana, have you guys ever gone to the uh hoosiers gym there outside indianapolis like where they filmed the high school gym oh hinkle hinkle yeah no no not butlers but the one where the high school games were in i think suppose you can drive out there and there's like a guy he'll take you on a little tour i grew up playing in mooresville which was this old gym which. It wasn't the Hoosiers gym. It was close. But it was the gym.

All right. So your Indianapolis sports teams? Yeah, Colts. All right. I was going to ask you Chicago team, Cubs or Sox. Ooh, Cubs. All right. Done.

I think that's it. So we'll put their website and their info in the show notes. And thank you, everybody. Thank you, Aaron. Thank you, Matt. Thank you. You've been listening to The Derivative. Links from this episode will be in the episode description of this channel.

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