Trend Following Manifesto

From Yahoo:

“Once in college, one in four students at four-year universities must take at least one remedial course to master what they should have learned in high school, government figures show. The most blunt assessment came from Microsoft chief Bill Gates, who has put more than $700 million into reducing the size of high school classes through the foundation formed by him and his wife, Melinda. He said high schools must be redesigned to prepare every student for college, with classes that are rigorous and relevant to kids and with supportive relationships for children. “America’s high schools are obsolete,” Gates said. “By obsolete, I don’t just mean that they’re broken, flawed or underfunded, though a case could be made for every one of those points. By obsolete, I mean our high schools - even when they’re working as designed - cannot teach all our students what they need to know today.”

One could very easily take Gates’ comments on education and apply them specifically to “trading & investing education”. Unfortunately, there is no easy answer to get people to see “right” ways and “wrong” ways when it comes down to money. Usually, the carefully crafted get rich quick scheme secures people’s attention — even though those schemes almost always implode.

I recently finished an interview in the Caribbean with a top trader. He currently manages over $1 billion in client capital using strict mechanical models. His dedication to master his niche over many years (by no means an overnight success) should be an inspiration to all. More to follow in the coming months…

Feedback on Citigroup “firing”:

“Hi Michael, I think it might be important to make the distinction that Citigroup never claims that technical analysis doesn’t work (even though it is likely that the type of predictive analysis they encourage from their hired analysts does not work). The real story here for trend followers is that Citigroup has decided that “it’s public” is not *buying* the technical analysis that Citi is selling. The move to allocate their corporate resources to funnymental analysis indicates that that is what the public wants. What a tremendous relief to trend followers! More evidence that regardless of facts, people like to spend their money on things that, “make good fundamental sense.” You know, like buying stocks that are, “undervalued,” and hanging onto losing trades when there is, “no fundamental reason,” for the decline. Sounds like Citi is preparing to provide some more profits for trend followers. In the words of the President…bring ‘em on!”
Jake Carriker

Some feedback on recent book review:

“The Welling@Weeden review and ensuing discussion on your blog brings to light a paradox of the demonstrable success of trend followers, which is that trend following’s success depends critically upon a market in which there are at least some participants who are NOT trend followers, who buy and sell based on fundamental analysis as served up by the many Weedens of this world, or (in the case of commodities) supply/demand factors. If every market particpant were an unadulterated trend follower, there would be no trend since prices in that case would be truly random. Be careful, when you cite the masses of institutional money apparently adopting trend following, of what you wish for.”
David Peipers

Thanks David, good point.

True it is zero sum game, but with this debate raging:

http://www.michaelcovel.com/archives/000308.html

…do you think it is likely that we will have ALL trend followers?

The debate continues:

Citigroup Eliminates Stock Technical Analysis Group

Trend followers are technical traders. However, unlike the fired group at Citigroup (and so many other banks and hedge funds), trend followers do not “project price trends in stocks”.

This distinction is huge. It is a core issue explained in my book Trend Following. That said, many still don’t get that there is a bogus form of technical analysis aimed at “prediction” and a very valid form of technical analysis aimed at “reaction” (used by trend following traders). Read more from another author missing the distinction:

Technical analysis–you’re fired! Is there any value to this controversial stock picking method?

I don’t know if the good professor Burton Malkiel (author of A Random Walk Down Wall Street) takes a position on technical trend following trading, but we sure hope he doesn’t deny that it works!

A great trend follower Larry Hite once said:

“I have noticed that everyone who ever told me that the markets are efficient is poor.”
Larry Hite
Founder, Mint Investment Management Company

Trend Following just started its largest print run yet. This is the 5th printing since release May 2004.

The recent review of my book “Trend Following” here has generated feedback:

“A couple of observations on your comments re: Kate Welling. To start, your book is a very good read. I have been following you, your site, etc. for some time and agree with your view of trading. Others have and will continue to make money in arbitrage, value investing, etc…The end story of the different methods boils down to understanding your style/method and sticking to it. If it were easy to get rich trading just by learning math, there would be a lot of wealthy former math teachers running around!…Back to Kate, understand that she works for Weeden & Co., a small broker dealer in CT. They have a small research product, trading, banking, etc. And that is what she sells! She works in a sellside shop that makes it’s living selling THEIR advice.”
Reader Feedback February 20, 2005

Welling@Weeden Writer Peter Deoteris Drops the Ball on Trend Following.

I received an email today that said in part:

“…you recently mentioned that you were in London discussing Trend Following with an academic who studies the possibility that the method may work…”
Michael D.

May work?

This professor knows like I do…that it works. You are not proffering that the traders in my book are the byproduct of “luck”?

Perhaps I am being too prickly with his choice of words. Perhaps he did not mean to use the word may.

The soft underbelly of the “trading advice” world opened wide.

From “Considering the Last Romantic, Ayn Rand, at 100″ by Edward Rothstein, New York Times, February 2, 2005:

“Rand divided her world - and her characters - in similarly stark fashion into what she wanted and what she didn’t want. Here is what she didn’t want: Ellsworth M. Toohey, “second-handers,” Wesley Mouch, looters, relativists, collectivists, altruists. Here is what she did want: Howard Roark, John Galt, individualism, selfishness, capitalism, creation.”

Man’s mind and his ability to develop his “self”, states John Galt, the protagonist of Atlas Shrugged, is his basic tool of survival. Life is given to him but survival is not. To remain alive, he must act, and before he can act he must know the nature and purpose of his action. In other words, to remain alive, he must think. Thinking is not an automatic process. A man can choose to think or to let his mind stagnate, or he can choose actively to turn against his intelligence, to evade his knowledge, to subvert his reason. If he refuses to think, he courts disaster: he cannot with impunity reject his means of perceiving reality.

The traits Rand wants her protagonists to demonstrate are also those of successful traders. Trading is a zero-sum game. It’s you against the world. It’s not you and your friend or you and your broker fighting together. You are left to objectively use your mind to determine the best course of action in order pull a profit from the other traders in the world who are competing with you at the game. You dig deep to develop a winning course of action. You don’t let fear overwhelm you. Pure fear is why the Nasdaq rose so far and plunged so low. And those who accepted their fear with confidence in their trading decision-making — made a killing.

From “In a Comback, It is Rally Time for the Dollar”, The Wall Street Journal, February 10, 2005:

“Yet unlike other relief rallies during the dollar’s three-year decline, this advance reflects something new: a rare belief that the widening U.S. trade and budget deficits could be coming under control. But can this new optimism be sustained? Some traders certainly think so. They point to a speech last week by Federal Reserve Chairman Alan Greenspan, who suggested that the dollar’s decline should help narrow the trade deficit. Then, on Monday, President Bush proposed a budget plan that calls for sharply cutting the shortfall by 2008. ‘We’ve changed the tone of the debate from one with ever-widening deficits to one where something is going to be done on both accounts,’ says Robert Sinche, head of global foreign-exchange research and strategy for Bank of America. ‘The future for the dollar doesn’t look nearly as scary as it did six weeks ago.’”
Craig Karmin

Why does Wall Street persist in believing that Alan Greenspan has a crystal ball? Is it the need to be optimistic? Patriotic? Or just the unquenchable thirst for fundamentals you can “trust”? And if you can’t trust fundamentals from the Federal Reserve Chairman…but doesn’t this whole debate miss the point?

If you have a trading strategy it must answer these 5 questions regardless of what Greenspan says on some odd day:

• How does the system determine what market to buy or sell at any time?
• How does the system determine how much of a market to buy or sell at any time?
• How does the system determine when you buy or sell a market?
• How does the system determine when you get out of a losing position?
• How does the system determine when you get out of a winning position?

From “The Wild West of Hedge Funds Becomes Tamer” by Gregory Zuckerman and Ian McDonald, The Wall Street Journal, January 24, 2005:

“There are about 8,000 hedge funds, and they pursue many different strategies, from aggressive tactics such as betting on growth stocks and currencies, to capturing small gains from arbitrage plays in the convertible-bond market. Sometimes these moves are more conservative than those of most mutual funds. And lately, hedge funds have turned to “long only” strategies that eschew short selling, or betting that a security will decline.”
The Wall Street Journal

Hedge funds are changing because they are being influenced by today’s investors who have neither the patience nor the tolerance to trade for absolute returns. Adopting mutual fund strategies of “long only” may feel less risky for the fund’s investors but will this conservative (and conventional) approach play well in terms of profits? It’s one thing to blow up using a bad strategy like Long Term Capital Management in 1998, but is the answer to mimic the S&P? I think not and I think any successful trend follower would agree with me.

From “How Wall Street Learns to Look the Other Way”, New York Time Op-Ed, Tuesday, February 8, 2005:

“Whatever happens with Mr. Grasso - and with Dennis Kozlowski of Tyco and the other avatars of corporate misconduct in the headlines these days - we should be reminded that ethical behavior for many business people must involve overcoming their learned biases. Perhaps these scandals would be a little less likely, and the rationalizations for them a little less tenable, if more of us professors integrated business education into a broader historical and psychological context. Would our students really fail to understand the economic models if we treated the subject matter not as an arcane specialty, but as part of a larger liberal arts education?”
Robert J. Shiller

Shiller may be a brilliant writer, he authored Irrational Exuberance, as well as professor, he teaches Financial Markets at Yale College, but he’s dreaming if he believes those on Wall Street behave unethically because of what they didn’t learn in business school. Learning to take responsibility for your actions, just like learning to trade properly, has little to do with a graduate degree in business or any other field.

From The Financial Times on February 9, 2005:

“Investors who buy shares in companies in fast growing economies are risking disappointment because there is no clear link between equity returns and GDP growth.”
The Financial Times

More importantly there is no clear link between the fundamentals (however those may be sujectively determined) and the price of the stock, currency, future, etc. You can have the greatest fundamentals in the world and still see a stock tank. Of course, and we should all know this now post bubble, the fundamentals can be terrible and a stock can soar.