Michael Covel: News & Info.

The clustering illusion is good food for thought.

“Economic theory goes only so far in explaining why people buy, sell, save or trust. Scientists are looking inside the mind for answers.” Read LA Times article (PDF).

Aspect Capital: London based trend following trader (PDF). With roots to some of the great trend following trading firms, Aspect Capital has become a major player in the managed money arena.

Do all trend followers start as trend followers? No.

Recently I spoke with a top trend follower who spent the first 15 years of his career trading, following and providing analysis on one market alone. He did not focus on other markets. How did he change?

His wakeup call came from another trader who was trading trends over multiple markets and spending little time to do it. How could this trend trader be doing other things during the day and not be focused on the constantly changing news and fundamentals. His lesson took quickly — trend followers are not glued to screens during the day watching quotes. They trade systems and systems give flexibility.

A few years later, and after a bunch of hard work, the transition from trading one market was made. He now trades multiple markets relying on the “price” as his trading trigger for entry, exit and position sizing.

Consider:

“Thailand’s commodities futures exchange launched tapioca starch futures trading on Friday but turnover was very thin as most tapioca dealers do not understand futures markets, the exchange’s president said. “We did not expect very high volume on the first day as players need time to be informed about futures trading,” said Napaporn Kurupasutachai, president of the Agricultural Futures Exchange of Thailand (AFET). Tapioca starch, which is used in the food, paper and toothpaste industries, became the third futures product on the fledgling exchange, behind rubber futures started in May last year and rice futures in August.”
Daily Times, Pakistan

It sounds like there is not enough liquidity to yet trade Tapioca starch, but once the volume is established and traders trust the exchange, trend followers have another potential market to apply speculation.

You know nothing of Tapioca starch? Trend followers don’t either. They also know little about the fundamentals of stocks, cattle, oil, euros, etc. It’s not about having mastery of each market, the trick is to treat every market the same and you do that by trading the “price”.

Building on yesterday’s conversation with a top trend follower, today in New York City I spent over half the day with one of the great trend following pros of all time. His trading career has spanned 30 years with many twists and turns. He is one very wise man - he gets it. This was the first time I had met this trader, but I did use a few of his quotes in my first book.

Why is he special? He is able to break down the complicated processes of life into chunks to better avoid the typical reasons people fail to accomplish their goals. He uses extreme focus on whatever entrepreneurial task he sets his mind too.

He also compares so many other aspects of life to trend following. One great example involved searching for oil. You will drill many wells with many of them coming up dry, but some will produce that black gold. If you know from the beginning that there will be many aborted attempts at success and that those attempts are a necessary part of finally finding oil, then you can accept the game as it is and deal with it.

It all gets back to a mindset of portfolio management. Not everything in a portfolio always makes money. Maybe once in a while everything will turn positive, but more often than not you will have the winners paying for the losers. Why do it this way? Like this great trader pointed out — he can’t predict and nor can anyone else.

I had a face to face conversation today in New York City with one of the best trend followers out there (trading many hundreds of $ millions). Like I mentioned the other day with another interview, this too is a man who I had never met before nor was he mentioned in my first book Trend Following.

What did I learn in a big picture sense? This man was influenced by a host of factors, but ultimately he came to his understanding of producing above average returns through his own detailed research. He pointed out that when he first started 10 years back he had no idea who the best trend followers were. He came to his aha moment through a series of small steps ultimately leading to the big idea: How can I capture those big moves, that arrive at unpredictable times, over a broad array of markets? His answer, now demonstrated with a track record exceeding +20% a year, was trend following trading.

There is a VHS tape out there about a very famous trader from many moons ago. It’s not my job to name it, but if you can find a copy, it sure is inspirational. The context and time period is somewhat dated (especially the fashion), but the men covered in the tape show a passion and energy that was the obvious key to their success. True entrepreneurs starting out whom today are legends. Great stuff. And no, I am not talking about gurus (Larry Williams, etc.) at retail seminars. This guy on the tape is still a player and a big one at that.

Yesterday I picked up the phone and called a top trend follower. His firm no longer reports their performance data, but they continue to trade billions making as much money as any one.

I had never talked with this man before and he was not in my first book Trend Following. Once his firm stopped reporting their performance data I forgot all about them — until yesterday.

This trader was at first uneasy talking with me. “How did you find me?” “Why are you calling?” But he had a good sense of humor, even though he quickly said that he did not want to be quoted on the record. We talked for 45 minutes.

His insights:

1.) He backed up the idea that many more Long Term Capital Management’s are ready to implode today. He said to look at the numbers of the arbitrage guys. He pointed out that for the last 4 years the arbitrage (”stat arb, convertible arb”) guys are using more and more leverage to generate less and less return (”too much gearing”). He added, “They think they have found the Key to Rebecca and they have not found anything.”

2.) He acknowledged that his billion dollar plus fund was on the other side of LTCM’s (Long Term Capital Management) losses in the zero sum game: “We were the other side…they were an accident waiting to happen…now 7 years later the risks for these types of traders are just as great.”

3.) Wall Street investment banks only want 35 year old traders. You get to be 50 and they don’t want you. What’s his point here? Wall Street ignores experience like Richard Donchian trading into his nineties. I know great trend followers ranging in age from 30 to 70. That’s his point.

4.) “When people’s emotions drive their decision making, systems traders have the luxury of being able to stick with it.”

There are a few guys out there arguing away with the concept of trend following. Their argument goes something like this:

“No one has shown me a single accepted statistical test that proves the existence of a trend. Our tests indicate randomness in most every market series…What I’m looking for is a formulation of method aside from the luck that keeps the rare practitioner of an essentially random system from going broke.”

If you bring up the track records of numerous trend following traders, they attribute any and all success to “luck”. Sure is a whole bunch of luck!

The bottom line? They really don’t want to know that trend following works. If trend following works, they look bad. If you spend a good part of your adult life yelling that something is not true and it turns out to be true, you lose face. I compare these guys to Mark McGwire’s recent steroids testimony. By all accounts McGwire is a decent guy facing terribly hard choices. The anti-trend following crowd faces the same bad choices. If they admit it works, they look real bad. But if they continue to say trend following doesn’t work, they look bad too. People and their egos don’t change.