From Bloomberg today comes an article that firmly backs the importance of the emotional component needed to be a great trend follower (or any trader for that matter):

“Functional psychopaths” make the best investment decisions because they can’t experience emotions such as fear, a study by researchers at Stanford Graduate School of Business showed. Fear stops people from taking even logical risks, meaning those who have suffered damage to areas of the brain affecting emotions, and can suppress feeling, make better decisions, the report showed. The ability to control emotion helps performance in business and the financial markets, the researchers found.”

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I wrote recently about having seen Jim Cramer’s TV show Mad Money for the first time. Yesterday traveling down to South Florida, I saw his show again on the plane’s TV. It’s one thing for Cramer to do this show circa 1999, but today in 2005 it’s almost criminally insane broadcasting. I notice that many people are justifying the show since it has a large audience. So even though the entire show is useless by any measure of investor sophistication, it’s alright since so many people watch it. Here is a good take on the show.

A good quick read (PDF) about how rather than shrinking risk, the behaviour of following the herd by investors adds to it.

Today I received:

“As a UK resident, I’ve just read the excellent book on Trend Following. To cut things short, re. the advice on p. 246, can you advise me how to find a trend following trader to trade for me.”

Sure, here is a good tracking service for trend following fund managers.

The Benefits of Managed Futures 2005 Update from the Center for International Securities and Derivatives Markets.

The Risk Matrix: Speed v. Impact (PDF) is from Choice Alternative Investments.

Of course an exceprt like the following should be read as “food for thought”, but there are some good insights:

“A new discovery may help explain where boneheaded investment ideas and get-rich-quick schemes come from. Researchers say two different brain regions may be involved in making risky vs. conservative investment mistakes, a finding that may eventually help economists build better models of people’s investment behavior. “Overall, these findings suggest that risk-seeking choices (such as gambling at a casino) and risk-averse choices (such as buying insurance) may be driven by two distinct [brain regions],” write Camelia Kuhnen of the Stanford University School of Business and colleagues in the Sept. 1 issue of Neuron.”

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From a reader today:

“Dear Michael, I wanted to say that “Trend Following” is now on my top three trading books list. I agreed with it so much that I ordered another copy that I sent to my brother-in-law the “skeptic”. More importantly, it inspired me to start my own business, called xxx. I’ll be using my software background to build custom trading systems, trade and risk management systems and other software for traders. The idea came to me when I read about Ed Seykota’s program that he runs everyday. I ended up building a trading system for myself based on some principles I had written out months ago on an index card. Then I started thinking that there may be other people who could use this as well. Again, excellent book — it really was a great read and one I’ll end up re-reading several times again I’m sure. Best Regards, Lou B.”

A reader writes:

“Just read Trend Following book and most comments revolved around commodity trading. I have been mostly trading pullbacks in momentum stocks, but it seems that I have been making more money on the up trending stocks. Where can I receive some info on trend following stocks?”

What is a momentum stock? What is a pullback? What exactly, down to numbered precision, is an up trending stock? This is just all jargon.

The term commodity is confusing when used by most. When the word is used, most people mean the futures markets and futures markets cover all markets across the globe including stocks. Trend followers don’t care what they trade and they surely don’t limit themselves to so-called “commodities”.

In this excerpt from Managed Account Reports the most successful Turtle offered:

“I think another mistake we made was defining ourselves as managed futures, where we immediately limit our universe. Is our expertise in that, or is our expertise in systematic trend following, or model development. So maybe we trend follow with Chinese porcelain. Maybe we trend follow with gold and silver, or stock futures, or whatever the client needs. It’s called managed futures because that was the profit center at the FCMs. We’re trading these great systems, and testing, and making sure what we do has worked in the past. And being disciplined, and unemotional, and applying our methods to the futures markets. But limiting our trading to this one group of markets. We need to look at the investment world globally and communicate our expertise of systematic trading. You have Big Blue beating the world chess champion, and everybody saying yeah, that makes sense, I can understand that. We’ve not been able to maximize our opportunities with systematic trading. People look at systematic and computerized trading with too much skepticism. But a day will come when people will see that systematic trend following is one of the best ways to limit risk, and create a portfolio that has some reasonable expectation of making money. We’ve got to be there and ready to take advantage of the opportunity. I think we’ve miscommunicated to our clients what our expertise really is. Systematic trading is going to be better for everyone in the long run. Our methods will work on lots of different markets. The ones that are hot today, the ones that are not hot today. We don’t want to pigeon-hole ourselves as managed futures or commodities.”

Some feedback just received:

“Greetings, just a thought from another trend follower. I hear the term risk used by investors/traders all the time. They are rightly concerned about risk, yet most do not know the source of risk, and, therefore, how it must be handled. For instance, I spoke with an experienced trader today. One statement really stuck out, “…oil stocks are too risky just like the internet stocks from a few years back…” He then used this reasoning as justification for why he currently won’t trade oil stocks. I tried to explain he was really talking about volatility – not risk. Stocks are not risky, they are volatile. Risk [on the other hand] is a part of one’s trading system. How much capital does one allocate to the oil sector? When does one open a position in the oil sector? When does one close that position? If you know the answer to these questions before your trade, you have already taken steps to reduce your risk. Refusing to trade certain stocks, futures, commodities, indices, options, currencies, etc. will not accomplish this.”

Got a call last night from a friend who told me to turn on CNBC. I did. I watched in amazement Jim Cramer’s TV show “Mad Money”. I specifically saw a feature called “Jim’s Call: Buy or Sell.” I can put it no blunter: if you watch this and you think this is useful, you need a mental examination.

More on Jim Cramer.

More on Jim Cramer’s Mad Money from Sfgate.com.

Here is an archive of my articles that I have placed on TradingMarkets.com.

Feedback received today from a client:

“Dear Michael, this is more of a commentary than a question. I just want to express my recent experiences and place a large exclamation point on being ready to accept losses prior to opening a trading account. My experience has been that due to the nature of any trading that cuts losses short and allows winners to run, a great percentage of the initial trades could very well show up as losses and upset a traders psyche…”

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Consider a recent email received:

“T-3 Fibs ProTrader day trading software is the most accurate predictive methodology ever produced for professional traders who wish to apply complete Fibonacci time and price predictions to their day trading in an effort to pinpoint HIGH probability turning points in price and time before they happen.”

Prediction is folly.

This excerpt came across my desk the other day:

“One cannot escape making an oil-price forecast. The demand-supply factors are still strong for oil and natural gas markets, leading some analysts to predict continued high or even higher prices over the next several years quite the opposite of what Mr. Gignac thinks will happen. With economists disagreeing and investment advisors no better at forecasting than anyone else, it is really up to investors to choose their own path. A complicating factor is the loose linkage between oil and gas stocks and commodity prices. Even if oil prices slip from the $60-a-barrel range into the $50-a-barrel range, it may be that oil and gas stocks would still be higher a year from now especially if enough market participants believe the oil price will stay high for some time. A recent commentary by Greg Pardy, an oil and gas analyst at Scotia Capital, noted that the stock prices for large oil and gas integrated and exploration companies in Scotia’s coverage universe were discounting only $45 oil. That means the market was not assigning any value to the share prices for the rise in the oil price above that level.”

How does one use this type of commentary to know when to buy? Or sell? Or how much to buy or sell? How does this type of fundamental analysis help answer the important questions? Do you really believe an oil forecast or prediction is possible?