Systematic trading strategies - The Donchian puzzle

Richard Davoud Donchian is one of the giants in the history of quantitative finance. In the literature you find him mentioned as "the father of trend following", "the inventor of managed futures", and the man who gave the name to the "Donchian channel" technical indicator. Even so, the facts known about the life and work of the twentieth century's most influential futures trader can be summarised on one page. The result is a jigsaw puzzle, with a lot of gaps.

Richard Davoud Donchian was born in Hartford, Connecticut, in September 1905. His parents were Armenian immigrants trading in Oriental carpets. In 1928 Donchian graduated with a bachelor’s degree in economics from Yale, and first joined his parents’ firm, where he started speculating in equities, inspired by the stock market best-seller, “Reminiscences of a Stock Operator”. In the stock market crash of 1929 he lost most of his investments, which was probably the starting point for his studies in securities analysis. At first, Donchian pursued this as a second occupation alongside his duties in the family company. In 1933 he joined the Wall Street brokers Hemphill, Noyes & Co. as an analyst (one of the many investment firms which in various ways later became part of the Shearson-Lehman empire). This period produced a document which is virtually unknown today: in “Twenty Trading Guides”, produced in 1934 for equities trading and modified in 1978 by the “Commodities” magazine for commodities, Donchian brings together general rules for action (e.g. “LIMIT LOSSES, ride profits”) and technical rules for good entry and exit points, which are still strongly influenced by the vocabulary of the Dow theory.

From Wall Street to LaSalle
After the USA entered the Second World War, Donchian first served in the landings in Sicily and then as a statistical officer in the US Air Force. Perhaps he had already begun to take an interest in the commodities market, perhaps not. It is, however, a fact that Donchian’s attention after the end of the war shifted from Wall Street to LaSalle Street in Chicago, the home of what was then the world’s biggest commodities future market. In the mid-40s the Chicago Board of Trade (CBOT) building was the highest and most impressive in the city on Lake Michigan. The huge trading floor, six stories high, housed the legendary pits, structures with the atmosphere of an amphitheatre in each of which a specific commodity was traded. However dignified the CBOT’s façade was, the action in the interior was very down to earth. The “open outcry” procedure that pit traders used to do business appeared to outsiders to be pure chaos, even in quiet trading. In hectic phases, the pits looked like a bar brawl which had got completely out of control.
The cowboy manners on LaSalle Street were a glaring contrast to the “gentleman’s business” on New York’s Wall Street, and being involved in futures markets was hardly seen as prestigious. Trading in corn, wheat, soy or copper was hardly a logical step for a graduate economist and Wall Street analyst like Richard Donchian. Like so much else, we do not know why he decided to get involved with CBOT and the other, smaller futures markets. Perhaps it was partly the fact that commodities prices after 1946 clearly delivered more of the fuel which most systematic trading approaches require: volatility.

Again, perhaps it was Donchian’s favourite subject, which runs as a key theme through the few publications we have: diversification. The commodities markets, then still much more strongly driven by various fundamental factors, offered more of this than the equities in the two Dow Jones indices. Strong support for this theory is provided by a Donchian quote from an article by the journalist and textbook author Darrell Jobman: “When I first got into commodities, no one was interested in a diversified approach. There were cocoa men, cotton men, grain men … they were worlds apart. I was almost the first one who decided to look at all commodities together. Nobody before had looked at the whole picture and had taken a diversified position with the idea of cutting losses short and going with a trend.”

The mother of all futures funds
Whatever the facts were, in 1948 (or 1949, according to some sources) Donchian founded the company “Futures Inc.” and opened it to investors. This is how the first vehicle for joint investment in commodities came into being the mother of all subsequent futures funds.
After 1960 Donchian headed the research department for commodities at Hayden Stone, another New York brokerage that also subsequently became part of the Shearson-Lehman Group. In this position he wrote a newsletter which appeared weekly until 1979 under the title “Trend Timing Comments”.

Futures Inc. – or at least the legendary “5/20 trading system” – continued to be managed from the 1970s to 1989 by Donchian’s personal assistant, Barbara Dixon. In June 1983 “Managed Account Report”, the leading publication of the day for managed futures, gave the first “Most Valuable Performer Award” for extraordinary services in the field of “Commodity Money Management” to Richard Donchian. He died on 24 April 1993, leaving the charitable Richard Davoud Donchian Foundation, which supports projects in the fields of education and health.And this is all the information available on the innovator of the managed futures industry from publicly accessible sources. This biography leaves many interesting questions unanswered. For example, how exactly did Donchian’s trading system “work”? How was Futures Inc. organized? What happened to the estimated 4,000 pages of newsletter Donchian wrote, after the demise of Shearson-Lehman? And what historical treasures might be hidden in these?Donchian was a man of the predigital age. As a result, anyone looking for answers to these questions has to dig deep. Contemporary witnesses are hard to find or unwilling to provide information. His personal assistant, Barbara Dixon, mentioned by name in the small biography on the Donchian Foundation website, today manages Spackenkill Trading in New York, a small CTA with an impressive track record. She could presumably supply many of the missing pieces of the puzzle, but did not reply to our enquiries for whatever reason.

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