Michael Covel

“What Edwards and Magee did for technical analysis and Benjamin Graham did for fundamental analysis, Michael Covel has achieved for the art of following trends. Arguably the definitive text on this style of trading, Trend Following covers all the bases from human behavior to systems trading, while debunking many prevalent misconceptions about what it really takes to make money. Covel gives it to you straight: what works, what doesn’t, and how outsized gains are earned, straight from the mouths of the world’s top traders. If you want the “quick path to easy trading success”, look elsewhere (And good luck to you!). But if you want a real education in what it takes to capture huge market gains over time, read this book.”
Mark M. Rostenko
Editor, The Sovereign Strategist

Review whitepaper on “happiness” from analyst James Montier at Dresdner Kleinwort Wasserstein: Download.

An excerpt:

If you are after specific investment advice, stop reading now. We seek to explore one of Adam Smith’s obsessions: what it means to be happy. We also discuss why that’s important to investors, and how we can seek to improve our own levels of happiness. The list below shows our top ten suggestions for improving happiness:

1. Don’t equate happiness with money. People adapt to income shifts relatively quickly, the long lasting benefits are essentially zero.
2. Exercise regularly. Taking regular exercise generates further energy, and stimulates the mind and the body.
3. Have sex (preferably with someone you love). Sex is consistently rated as amongst the highest generators of happiness. So what are you waiting for?
4. Devote time and effort to close relationships. Close relationships require work and effort, but pay vast rewards in terms of happiness.
5. Pause for reflection, meditate on the good things in life. Simple reflection on the good aspects of life helps prevent hedonic adaptation.
6. Seek work that engages your skills, look to enjoy your job. It makes sense to do something you enjoy. This in turn is likely to allow you to flourish at your job, creating a pleasant feedback loop.
7. Give your body the sleep it needs.
8. Don’t pursue happiness for its own sake, enjoy the moment. Faulty perceptions of what makes you happy, may lead to the wrong pursuits. Additionally, activities may become a means to an end, rather than something to be enjoyed, defeating the purpose in the first place.
9. Take control of your life, set yourself achievable goals.
10. Remember to follow all the rules.

If sports is a game, why do its lessons last a lifetime:

“The dignity is in the risk they take, not the mistakes they make.”
Thomas Boswell
Washington Post
November 27, 2004

Review the following paper:

Download

An excerpt:

“On March 10, 2000, the Nasdaq Composite Index closed at its all-time high of 5,048.62. For comparison, the same index stood at 1,114 in August 1996 as well as in October 2002. The unusual rise and fall in the prices of technology stocks has led many academics and practitioners to describe the event as a stock price “bubble.” This label seems appropriate if the term “bubble” is interpreted as an ex post description of an extended rise in prices followed by a sharp fall. However, a more common interpretation is that the prices of technology stocks exceeded their fundamental values in the late 1990s. This paper analyzes whether technology stocks were indeed overvalued at that time.”

The bottom line is the market went straight up to around 5000 and then straight back down. You either made money or not. Attempting, in hindsight, to explain whether it was a bubble or not, doesn’t seem to help explain how one would have traded that market — for profit.

Crowds move for interesting reasons. Food for thought:

“A fight breaks out, and even though people at the far side of the crowd can’t see what’s going on, they are immediately on edge. Now, a Harvard researcher has an explanation for this fear contagion, the quick spread of emotion through a crowd. Seeing someone adopt a fearful posture triggers areas of the brain that express emotion and get the body primed for action. It’s a response that can race through a crowd like wildfire. “We are extremely sensitive to emotional body language, and we react to it without us being aware of it,” said Beatrice M.L. de Gelder of Harvard Medical School. This, she said, “is very good, because that puts us in a position to act.”"
Randolph Schmid
Associated Press

Read Complete Article

Whether a report card or stock, a trend down is a trend down.

The German Traders magazine offers this review of Trend Following:

Read Part 1

Read Part 2

“In Trend Following, Michael Covel provides the most complete and concise guide to trend following to date, exploring the sometimes forgotten technique and its billionaire followers. It is both enjoyable and thorough, making it invaluable reading for all traders, even if they have only a mild interest in trend following, or are doubtful of its success. For a technique that is performing at a consistently high level, and is constantly being re-discovered, Trend Following is the definitive guide.”
Traders Magazine (English version)
December 2004

From Yahoo Finance Sunday night EST:

“While Wall Street’s post-election euphoria finally fizzled last week, the fundamental health of the market remains strong — profits continue to grow, the market remains only slightly overvalued at the moment, and the economy is growing, albeit at a slower pace than in the past. Because of that, most analysts expect the market to resume its rise through the end of 2004 and into January.”

Questions for the writer:

1. How do you measure the “fundamental health of the market” objectively? And if you can, how does that tell you when to buy or sell?
2. How do you tell if a market is “overvalued”?
3. Who are “most analysts”?

Let me put it bluntly: If you are looking for some guru to give you buy and sell signals, but never give you the logic or rules behind those signals, you are in trouble. The moment you realize there are no gurus is the moment you are one step closer to the worthy goal of out-sized profits.

Food for thought:

“Only recently academia has conceded that markets are inefficient to various degrees. There are numerous causes for these inefficiencies: apart from the fact that investors do not act on a completely rational basis and that information is not available to all participants in the market to the same extent at the same time, a further key cause of market inefficiencies is that the great majority of investors are subject to considerable restrictions on their investment activity. These restrictions are, on the one hand, of a legal nature. On the other hand, however, they are also rooted in the investor’s own investment strategy. The manager’s ability to exploit exactly these inefficiencies and thus create returns that are independent of the traded market’s direction is expressed by the factor ‘alpha’, whereas the ability to achieve (positive as well as negative) returns by simply tracking the markets is defined as ‘beta’.”

While we agree with the author, we disagree that academia has conceded markets are inefficient. Some have, most have not!

From Bloomberg News yesterday…another myth clings to life:

“Crude oil plunged as low as $45.25 yesterday, after falling below $45.485 a barrel, said Steve Taylor, a trader with New West Petroleum Inc. in Sacramento, California, citing charts traders watch to predict price moves. A Fibonacci graph of the increase from June 30 to the peak of $55.67, identifies $45.485 a barrel as the 50 percent retracement of the rise. Fibonacci analysis is a tool, named for a 13th Century mathematician, which is used by technical traders who chart historical prices and volumes to discern trends and turning points in a market. ‘That spooked a few people out of the market,’ said Steve Taylor, a trader with New West Petroleum Inc. in Sacramento, California. ‘We saw the funds liquidating all day long.’”
Bloomberg News

Fibonacci as prediction? Not exactly: read.

Lesson? Think critically.

Take personal responsibility. No blame games. That is Mark Gilbert’s point:

“Hedge funds, already the usual suspects whenever financial markets go awry, stand accused of suffocating the very market anomalies they rely on to beat their less adventurous peers in the investment community. The “prosecution” alleges that with $866 billion chasing identical strategies, any arbitrage opportunities in markets where hedge funds are active disappear too fast for anyone, including the hedge funds, to make a buck. It all smacks of sour grapes from those who either regret not jumping on the hedge-fund bandwagon, or are struggling to turn a profit this year. Traders and investors feed on volatility. The bigger the price swings of a stock, bond, commodity or whatever, the greater the profit potential. When markets flatline, it’s harder to make money or, to use the current odious idiom, to “generate alpha.”
Mark Gilbert
Bloomberg News

Volatility ebbs and flows…just like price movement. Keeping track of volatility and responding to current levels with a direct plan of attack — separates the winners and losers.

Consider from this weekend’s Barrons:

“Margins of the sort Google generates invariably attract new entrants, so it’s no surprise Microsoft wants a piece of the action. But the process invariably squeezes margins as companies spend to grab consumers’ attention. J.P. Morgan estimates Google itself will boost research and development spending 60% and sales and marketing expenses by 54% next year. If Google doesn’t continue to keep generating top-line growth, or R&D and marketing expenses increase even more, margins obviously would suffer. Whether Google’s inside shareholders will stick around to find out is another question. Lock-up restrictions on 270 million shares will be lifted within six months of the August IPO, including nearly 40 million later this month. CNET reported last week that the Web developer who drew those cutesy holiday logos for Google’s home page registered to sell 2,495 shares for a profit of $489,000 at recent prices. If you saw dot-com stock gains go up in smoke all around you four years ago, what would you do?”
Barrons

What you should do is trade the trend. Don’t try and predict the trend, just trade it either up or down. If you get out now — what if the share price doubles? Forget price targets, they are not wise. Ride the trend as high as it can go, but just make sure you have an exit plan or go short plan at some point when the trend ends.

Number of days between Red Sox World Series triumphs: 31,459.

The fabled mathematical concept, PI (of PI R SQUARED fame): 3.14159.

Source: ESPN.

People often ask, “can I invest with trend followers through my retirement program?” Good question. The short answer is that it depends on what kind of retirement program you have. For example, Lincoln Trust offers flexible programs that go well beyond the “standard issue corporate retirement plan”.

Along the lines of “retirement flexibility”, consider:

“For a quarter-century, a Boston inventor has been obsessed with a single idea: an innovation that would give millions of American workers the chance to borrow their own money from their 401(k) savings plans using a new kind of credit card.”

Read article here.

For those that continue to be “long only” or said more directly “buy and hopers”, the following white paper is food for thought: Long Short White Paper from Deutsche Bank Absolute Return Strategies.

Thought about alternative markets recently? Consider: ‘The Futures of Risk’ White Paper from Hedgestreet.

A good map showing exchanges and trading growth across Asia.

John G. Miller’s The Question Behind the Question is a great, quick read about personal accountability. Do you ask “why” or “how”?

Winners are different: read PDF report.

“There’s a strong human tendency to mull over the past and think that what has happened in the past has a strong impact on what will happen in the future. We tend to believe that we can learn from our past mistakes, and we often do. But there are times when there is little to learn, and it is useful to move on and see what happens next, instead of unnecessarily mulling over past losing trades that were just a fluke. Seasoned traders warn that it is not wise to get bogged down by a series of unexpected losing trades that were just a matter of market “noise.” It makes no sense to take things personally or to place more significance on a setback than is warranted. It is important to learn to pick yourself up after a setback. Think optimistically. There is always a new play to develop. There’s the next pitch, the next opportunity where you can come out ahead. You can’t let a series of losers ruin what could happen next. Athletes have known this for quite some time. Whether it is tennis, football, losing a sale, or trading, it doesn’t make sense to let yourself get stunned and stagnate. It’s better to just say, ‘Okay, I made a mistake, what’s next.’”
Innerworth.com

The last few months have seen various reports of hedge funds changing their strategies to “long only”. Long only? Exactly, just another way to say buy and hold. Long only trading is limiting. Consider the wisdom of avoiding the “long only” constraint:

“The long-only constraint is so automatic in investment management that, often, we don’t even think about it. Yet this pervasive constraint can dramatically reduce efficiency and induce small stock biases — and these negative impacts increase with active risk. In fact, the advantage of long-short products [for example trend following trading] is the avoidance of the long-only constraint.”
Ronald N. Kahn
Canadian Investment Review

Buy & hope, buy & hold or long only — it’s all the same thing. The best traders do not just “buy”. The best traders enter markets, long or short, always with an exit plan. If you don’t have an exit plan as you enter, how do you know to ever get out?

Read PDF story for more information about the long only debate.

Some thoughts about affect, reason, risk, and rationality by Paul Slovic, Melissa L. Finucane, Ellen Peters, and Donald G. MacGregor.

Download PDF report now.