Michael Covel: News & Info.

I am in the middle of an extensive set of informational interviews with some of the great traders of today. I just finished a meeting yesterday with the President of a trend following firm who manages over $3 billion dollars for clients. A very down to earth guy, his most direct advice was for people to focus on their plan and not stay preoccupied with others’ plans. He drove home the point that if you dare to be great, in whatever your chosen profession, standing outside the crowd is where the great rewards will be found. If you only want to work for the man, you can’t be the man.

Read:

“In his highly popular annual letter to shareholders, America’s second-richest man expressed regret that his bet against the dollar had been so profitable, and urged the US administration to take action to deal with its widening trade gap and budget deficit. Mr Buffett, 74, one of America’s most successful businessmen for the past half century, said: “In no way does our thinking about currencies rest on doubts about America.”
Independent News & Media (UK) Ltd.

Read more:

“Warren Buffett, the world’s second-richest person, last year increased his bet against the U.S. dollar 78 percent to $21.4 billion, resulting in a $1.84 billion gain. He also said he would be happy if his bet were to fail.”
Reuters

I understand he is the richest guy out there, but this kind of talk is disingenuous. Do you really think he is “sorry” he made money shorting the dollar? I am sure the loyal buy and holders will ignore all of this and just blindly pretend that Buffett is still the “folksy” hero to the “everyman”. Why can’t Buffett just admit, “I made a great trade on the dollar?” This “I feel guilty” routine is just that - a routine.

NOTE: Please don’t ask whether I think Buffett is a success. Of course he is - a monster one. That is not my point.

The greatest “investor” Warren Buffett is trading like a trend follower these days:

“Mr Buffett’s bet against the dollar also grew. Foreign exchange contracts - mostly short positions against the US dollar–nearly doubled over the year to $21.4bn, generating $1.8bn in gains as the greenback fell against other major currencies. These currency profits were partly responsible for a sharper than expected rise in fourth quarter earnings from $2.39bn to $3.34bn, although Berkshire earnings are notoriously volatile due to the timing of investment gains.”
FT.com
March 5, 2004

That is some serious profit for Mr. Buffett! Buy and hold out the window!

NOTE: Please don’t ask whether I think Buffett is a success. Of course he is - a monster one. That is not my point.

“Men Behaving Badly” whitepaper explains “irrationality in decision making when defeat becomes hard to accept.”

Download now.

Food for thought:

“What kind of risk are you willing to take to get this profitability? Consider whether you are willing to suffer the occasional large loss in return for consistent small profits. For example, risk arbitrage as a trading strategy has lots of small profitable trades but the size of the average winning trade is overshadowed by the size of the losing trade. Do you need to make modest profits but take little risk? Do you need to make huge profits but can afford to take sizable risks? I usually start interviews with potential clients by asking them how much risk they are willing to take. Can you afford a loss of 5%? How about 50%? Defining the amount of risk usually defines the type of system that is required. Don’t forget that it is very easy to acquire risk. One of the keys of profitable trading is controlling and managing the risk that is acquired. One of the key risk elements to look at is the risk of catastrophe. For example, it may be that two systems have identical returns but one has a higher risk of catastrophe. I remember in the early days of system trading how moving average crossover systems were all the rage. The basic concept is to buy the instrument when the, say, 10-day moving average of price crossed over the 40-day moving average of price, and short when the reverse occurs. In fact, this is a profitable system. But one of the problems is that moving averages are, by definition, behind the market. It is quite possible for an instrument to lose 90% of its value before the sell signal is triggered! Of course, it won’t happen very often, but the mere potential of this risk must be considered in the system selection process.”
Courtney Smith
Chairman, Courtney Smith & Co.

Great trend followers don’t debate their signals when they arrive. They know that they have done their homework. They know their success comes from the discipline to follow their rules - no matter what. Trend followers don’t get entry or exit signals and apply some extra layer of “human judgment”. They don’t try to be smarter than the “system”.

Now think about this “football coaching” excerpt, keeping in mind the importance of following a system:

“A very significant story for the future of Drew Bledsoe in Buffalo happened, of all times, during the coin flip before the season’s last game against Pittsburgh. Big game for Buffalo. Very big. A win over Pittsburgh, which would be resting some of its stalwarts, and the Bills were still in the playoff hunt. Winds were whipping up pretty strong that day — 17 mph. Before he walked out to midfield for the flip, Bledsoe was advised by coaches to choose to defend the east goal if Pittsburgh won the toss and elected to receive. That way, the Steelers wouldn’t be wind-aided when they took the ball. Pittsburgh won the toss. Pittsburgh elected to receive. Bledsoe said Buffalo would defend the west goal. West? We told him east! The Bills sideline was stunned. What is God’s name was Bledsoe doing? Bledsoe explained that when he got to midfield, it seemed to him the wind was whipping around differently than the way the coaches thought, and so he picked the opposite goal to defend. There was some anger toward Bledsoe on the sideline, and maybe it was just coincidental, but the Steelers scored 23 of their 29 points going from west to east that day — and Bledsoe’s decision backfired. Sometimes, coaches don’t want players to think. They want players to do what they’re told. Bledsoe defied the Buffalo staff that day, a sort of subtle defiance that began to irritate the Bills coaches the same way it had irritated Bill Belichick’s staff four years earlier. That simple act didn’t get Bledsoe unemployed. Three very big Bills losses this year (at New England, at Baltimore, and that Pittsburgh game), in which he threw zero touchdowns and eight interceptions, helped Mike Mularkey decide he’d be as well off playing J.P. Losman, a kid he knew had some mobility and, more important, would follow instructions.”
ESPN
Better without Bledsoe
Patriots built dynasty by sticking with Brady
Sunday February 20, 2005

As you trade, no matter the style employed, you need to be aware of the competition. And when you think of the competition, you better think how their trading affects you. You can’t just sit back and ignore the world. From the ground up your trading philosophy needs to be aware of other market participants and specifically other market participant’s varying time horizons. Trend followers might be fine with the belief that price analysis already factors the competition, but shorter-term systematic traders better be aware of Jim Simons.

An excerpt to ponder:

Question: Besides the obvious of price determining trend formations…What key factors would one look for in order to reinforce the belief that a trend is in fact developing?

Ed Seykota: Your focus on “trend formation” and “trend developing” indicates a desire to anticipate trends. Such attempts to “pick the bottom” are things fundamentalists attempt. Trend Followers simply wait for trends to appear.

I finished an interview today with a trend follower based in New York City. He has been at it for 30 years. His firm, like my recent Caribbean interview, also manages over $1 billion in client capital. In a wide-ranging conversation about trend following’s lack of acceptance in some quarters, he pointed out that for many people “investing with skill” is hard to understand. Trend following is a skill. You can learn that skill or you can hire a trader who has the skill. But either way skill does matter when you are aiming to beat market averages. More to come in the near future…

Ed Seykota was recently asked in his forum:

“I am new to trend following and wish to ask you what your favorite chart is for determining a given market’s trend? Daily, Weekly, Yearly, Hourly?”

Ed responded:

“Hmmm…your list seems to lack scaling options for minute, second, and millisecond. If you want to go for the really high frequency stuff, you might try trading visible light, in the range of one cycle per 10-15 seconds. Trading gamma rays, at around one cycle per 10-20 seconds, requires a lot of expensive instrumentation, whereas you can trade visible light “by eye.” I don’t know of even one short-term trader, however, who claims to show a profit at these frequencies. In general, higher frequency trading succumbs to declining profit potential against non-declining transaction costs. You might consider trading a chart with a long enough time scale that transaction costs are a minor factor - something like a daily price chart, going back a year or two.”

I agree with Ed’s pithy wisdom, but he is not saying short term is impossible.

There do exist shorter term systematic traders who have done quite well (Toby Crabel, Jim Simons). They would agree with Ed that their style is hard. The shorter you go the more you need great execution, fantastic data and multiple systems. To be a great shorter term mechanical trader is a different animal than trend following, but it is a style that a select few have mastered.