Michael Covel: News & Info.

HedgeStreet Inc., which lets investors trade a kind of derivatives online, is now letting participants “hedge” or speculate on the direction of home values in major U.S. real estate markets. The new Housing Price Hedgelets are tradable as both Yes/No and Variable contracts with three-month and six-month durations and are benchmarked against the National Association of Realtors reported median sales price of existing single-family homes in Chicago, Los Angeles, Miami, New York, San Diego and San Francisco. “For most Americans, their home is their single largest investment and, as such, the desire to reduce risks surrounding that asset is important,” said John Nafeh, HedgeStreet’s chief executive officer. “Housing Price Hedgelets provide a unique way for them to hedge against depreciation in the value of a home, or conversely, speculate on the degree to which housing prices will appreciate.”

James Altucher recently posted an article on trend following. The article has brought forward an abundance of feedback. One trend follower wrote me to say:

“JWH and the like advertise the riskiness of their investments on their sleeve, while some of the mean reversion hedge fund boys spend sleepless nights hoping no one ever figures out how much risk they are really taking. Who am I kidding? Most of those guys won’t even admit to themselves how much risk they are taking!…there are many different frameworks that one may view the markets through in order to make trading decisions. All such frameworks are what they are, simply illusions that we create in order to help us take some action (yes, even trend following). The test of whether such a framework is useful in the long run is whether it supports us in doing profitable behaviors. If our framework helps us ride winners, cut losses, and manage risk then it is likely to lead us to profits. If the framework is not consistent with these things, then it is likely just part of a bigger game we play to meet some emotional needs and learn some important lessons with some help from the markets…Strategies like the ones Mr. Altucher mentions are not inherently bad. However, by nature they attract investors that have emotional needs that the strategies appeal to (low apparent volatility, feelings of offering value), and the investors are often eager to overlook many of the very real, but hidden, risks involved. It might take a superhuman manager to consistently manage such hard to see risks in the face of constant temptation to go for bigger returns. I don’t like to set up situations where my financial well-being rides on someone consistently exhibiting superhuman skill and willpower. I would rather put my money in something that any idiot can manage as long as they don’t try to get too cute and go around trying to avoid drawdowns.”

My friend added more for those who think they can avoid volatility:

“If one focuses on the volatility of a trend trading strategy while understating its returns, and at the same time one ignores the “one time few-and-far-between huge drawdown events” typical of strategies that are built to avoid short term volatility of returns and one emphasizes the smoothness of the returns that exist outside that one time event, then one has an easily defeatable straw man trend follower to argue against. Reality shows us that strategies that have higher returns have higher risks. If you think you can get high returns without the commensurate level of risk, you might be prone to investing in strategies that do an excellent job of avoiding risk on 99.9% of days, but blow up on the other .1% of trading days.”

(more…)

Trend Following is currently ranked #1 in the “stocks” category at Amazon, #1 in “options” books and #2 in “futures” books. Thank you for the continued support.

Michael Mauboussin of Legg Mason, back in his CSFB days, authored an interesting persepctive on the “lead steer”. Read PDF report.

Donchian’s Trading Guides

Richard Donchian documented his trading guides in 1934. He reviewed them in 1974, noting the ones he felt were the more important, some 40 years after they were first documented. The more important rules are reproduced:

General Rules:

1. Beware of acting immediately on widespread public opinion. Even if it is correct, it will usually delay the move.
2. From a period of dullness and inactivity, watch for and prepare to follow a move in the direction in which volume decreases.
3. Limit losses and ride profits, irrespective of all other rules.
4. Light commitments are advisable when a market position is not certain. Clearly defined moves are signalled frequently enough to make life interesting, and concentration on these moves to the virtual exclusion of others will prevent unprofitable whipsawing.
5. Seldom take a position in the direction of an immediately proceeding three-day move. Wait for a one-day reversal.
6. Judicious use of stop orders is a valuable aid to profitable trading. Stops may be used to protect profits, limit losses and take positions from certain formations such as triangular foci. Stop orders are apt to be more valuable and less treacherous if used in proper relation to the chart formation.
7. In a market where upswings are likely to equal or exceed downswings, a heavier position should be taken for the upswings for percentage reasons; a decline from 50 to 25 will net only 50% profit, whereas an advance from 25 to 50 will net 100%.
8. In taking a position, price orders are allowable. In closing a position, use ‘market’ orders.
9. Buy strong-acting, strong-background commodities and sell weak ones subject to all other rules.
10. Moves in which rails lead or participate strongly are usually worth following more than moves in which rails lag.
11. A study of the capitalization of a company, the degree of activity of an issue and whether the issue is a lethargic truck horse like Consolidated Edison or a spirited, volatile race horse like Case Threshing Machine is fully as important as a study of statistical reports.

Nicolas Darvas wrote How I Made 2,000,000 in the Stock Market years ago. There are many good lessons in it. A very relevant quote from Darvas’ second book:

“My only sounds reason for buying a stock is that it is rising in price. If that is happening, no other reason is required. If that is not happening, no other reason is worth considering.”

Sound like trend following?

In Time magazine in 1959 Darvas, the one-time dancer, was quoted as saying:

- “In my dancing I know how to judge an audience. It is instinctive. The same way with the stock market. You have to find out what the public wants and go along with it. You can’t fight the tape, or the public.”

- “I have no ego in the stock market. If I make a mistake I admit it immediately and get out fast…If you could play roulette with the assurance that whenever you bet $100 you could get out for $98 if you lost your bet, wouldn’t you call that good odds?”

- “I never bought a stock at the low or sold one at the high in my life. I am satisfied to be along for most of the ride.”

- “I am only in infant industries where earnings could double or treble. The biggest factor in stock prices is the lure of future earnings. The dream of the future is what excites people, not the reality.”

James Montier, an analyst with a behavioral finance edge, offers:

“Leaving the trees could have been our first mistake. Our minds are suited for solving problems related to our survival, rather than being optimised for investment decisions. We all make mistakes when we make decisions. Avoiding the most common investment mental pitfalls:

1 - You know less than you think you do.
2 - Be less certain in your views, aim for timid forecasts and bold choices.
3 - Listen to those who don’t agree with you.
4 - You didn’t know it all along, you just think you did.
5 - Don’t take information at face value, think carefully about how it was presented to you.
6 - Vivid, easy to recall events are less likely than you think they are, subtle causes are underestimated.”

As mentioned the other day, I have spent the better part of the last 4 months interviewing 10+ great traders at their offices. This group manages collectively well over $10 billion USD.

I have met with both trend following traders and short-term systematic traders. The idea has been to assemble a representative sample of those traders excelling in the non-fundamentally based trading world. In a world still dominated by traders analyzing balance sheets and crops reports for their trading decisions, talking with great traders that make big money using statistically-driven trading models has been filled with “aha moments”.

As the research process continues, I would like to now use the power of the web to find other interview candidates across the globe. If you currently trade trend following models or if you currently trade short-term systematic models, I would like to discuss a conversation for a future book. Feel free to contact me here. You do not have to be a trading manager to participate, you could simply be trading your own account. All communication on this issue will be considered private until all parameters are agreed upon.

Sometimes 2think.org is the perfect tonic. Consider some of my favorites:

“When you make the finding yourself–even if you’re the last person on Earth to see the light–you never forget it.”
Carl Sagan

“If you try to impose a rigid discipline while teaching a child or a chimp you are working against the boundless curiosity and need for relaxed play that make learning possible in the first place… learning cannot be controlled; it is out of control by design. Learning emerges spontaneously, it proceeds in an individualistic and unpredictable way, and it achieves its goal in its own good time. Once triggered, learning will not stop–unless it is hijacked by conditioning.”
Roger Fouts

“A man’s ethical behavior should be based effectually on sympathy, education, and social ties; no religious basis is necessary. Man would indeed be in a poor way if he had to be restrained by fear of punishment and hope of reward after death.”
Albert Einstein

“The biggest cause of trouble in the world today is that the stupid people are so sure about things and the intelligent folks are so full of doubts.”
Bertrand Russell

“Fear is the main source of superstition, and one of the main sources of cruelty. To conquer fear is the beginning of wisdom.”
Bertrand Russell

From a Graham Capital presentation, this chart is a simple reminder of the trend following typical “winner”: