Leo Melamed offers this perspective on the future of futures (PDF). An excerpt:

“Clearly there will be new financial scandals. Long Term Capital Management, Enron, WorldCom, Allied Irish Banks taught lessons that greed will quickly erase. While those scandals caused some hand wringing and finger pointing at derivatives markets, by and large they did not impede their growth. Indeed, one can make the case that while such scandals result in intensified scrutiny by regulators, they often serve to increase rather than decrease the use of risk management applications provided by our markets. Above all, such scandals often underscore the need for transparency that is best provided by organ- ized futures exchanges.”

A recent article of mine covering “risk” basics (PDF).

Theresa Lo offered a nice comment on price:

“I know you’re used to reading financial blogs that opine ad nauseum everyday. I have no idea how they do it, nor am I going to try. You see, I show up each morning to make money; cash facilitates life. I don’t care for conspiracy theories or consider fiat currency an Ayn Rand moral dilemma. I won’t waste time tracking the defunct M3. Who cares if the Plunge Protection Team is real or not? @*$%@#$ corporate greed. I cannot right the alleged wrongs of capitalism – that’s what the SELL button is for. Use it. I simply accept the Darwinian nature of the markets. There is a financial circle of life and it cannot be defied. There is no good or bad. There are only profits or losses. That’s why tracking and trading price is the way to go. In an imperfect world, it’s all we have.”

The Nasdaq has been dropping. I have no idea why, nor do I believe anyone else really has an idea why it has dropped. Consider the chart:

Nasdaq

Imagine all you have is that.

Even if you had all of the “news”, “opinions” and “analysis” from the last 6 months, how would it help you to trade that chart? Many trend following programs, if in the Nasdaq, are most likely short now. Does that mean they are right about direction? No, it just means that a directional shift has happened. When just staring at the chart, don’t you feel more secure using daily price data for decision-making v. “news” and “opinions”?

Recent feedback:

“Please relay to Michael my thanks. I’ve spent the last two and half years trading commodities and trashing back and forth between success and failure. After applying trending following principals from his book, my portfolio and I feel like we have direction. No more thrashing. Granted I’ve been in a hot copper, gold, and silver market but the fact that I was in it and not trading IN and OUT can be traced to Michael. I’ve taken my $60,000 to $330,000 in 2 months, and I’m no longer stressing over market moves like I did during my “TRASHING PHASE”. Please thank him again.”

Thanks, but…

Two months does not make a sample size of note! I am gald you have made some money, but be careful. There will be ups and downs and you need to be ready for those.

An interesting article about crash talk (PDF). You never know when or if everything will really take off, but if markets all go sharply, trend followers will be there.

Ben Stein lays out strong thoughts on the responsibility for high oil prices here (PDF). An excerpt:

“The energy companies — by and large and with some exceptions — just go out into the market, like you and me shopping at the grocery store, and buy oil, process it, and then sell it with a small markup to pay them for their efforts and to reward their stockholders for risk. This profit is pennies compared with what stock brokerages, software makers, and other major U.S. companies earn on a percentage basis of sales. In other words, the oil companies are just messengers announcing to energy-consuming Americans the news about oil prices.”

I agree 100%. Later he adds:

“As for me, I question if the commodities boom can go on forever. I have some of the funds I just mentioned, but not a lot. Commodities booms come and go — historically, they’ve never gone on forever. If you think this one will, here’s a hint. When people say, “Hey, this nonstop boom has never happened before,” and someone responds, “This time it’s different,” hold onto your wallets. “This time it’s different” is one of the most frightening phrases in economics. It’s entirely possible that the next move for oil is a long step down. Then won’t we be sorry for shooting the messengers?”

I agree here too. The idea, the trend following mantra, is not to predict bull or bear markets, but rather to follow along the market direction with a precise plan for exit always in mind.

Review this recent article (PDF). An excerpt:

“New market high points inevitably are when many would-be investors begin to fret that everyone is getting rich but them, but the time is already past to make big money in the markets. With the Dow Jones industrials and other major market indexes flirting with historic highs, is this one of those times? A variety of investment professionals and strategists don’t think so. Each expressed the belief that the U.S. equity market’s steady, slow climb back from the 2002-03 trough has been driven by bedrock, fundamental strengths in the economy, not speculation. They also say there’s very little reason to believe we are at a peak, with a diverse mix of inexorable demographic and economic forces, both here and abroad, pointing to sustainable underlying business performance. In short, while short-term profits in the stock market are never assured and are dodgy to predict, the long-term chances of building wealth are pretty good, even if you start investing now. Yet even in the short term, analysts say there are many good reasons to be optimistic about the stock market and the economic cycle in the next year or two.”

If you follow the advice above, how does it help you to answer these questions?

1. How do you determine what market to buy or sell at any time?
2. How much of a market should you buy or sell at any time?
3. How do you determine when you enter a market?
4. How do you determine when you exit a losing position?
5. How do you determine when you exit a winning position?

As a former baseball catcher, I found this excerpt and associated PDF useful in thinking about trading success:

“Baseball metaphors run through business speak as easily as Willie Mays ran down fly balls. But too often, writes consultant and baseball columnist Jeff Angus in Management by Baseball (HarperCollins, May), business fails to live up to the American pastime. Fast Company (PDF) shared a bleacher with him at a spring-training game of his hometown Seattle Mariners.”

In the PDF, this line caught my eye:

“It helps to think like a catcher, which is why so many become good managers. A catcher always has the whole play in front of him and can think critically about what he sees.”

A definition of technical analysis seen recently:

“Technical analysis uses deviations from the efficient market hypothesis to make best guesses about future movements in the financial markets.”

I have a different take in my book:

Now here is where the understanding of technical analysis gets tricky. There are essentially two forms of technical analysis. One form is based on an ability to “read” charts and use “indicators” to divine the market direction. These so-called technical traders use methods designed to attempt to predict a market direction. Here is a great example of the predictive view of technical analysis: “I often hear people swear they make money with technical analysis. Do they really? The answer, of course, is that they do. People make money using all sorts of strategies, including some involving tea leaves and sunspots. The real question is: Do they make more money than they would investing in a blind index fund that mimics the performance of the market as a whole? Most academic financial experts believe in some form of the random-walk theory and consider technical analysis almost indistinguishable from a pseudoscience whose predictions are either worthless or, at best, so barely discernably better than chance as to be unexploitable because of transaction costs.” This is the view of technical analysis held by the majority—that it is some form of superstition, like astrology. Technical prediction is the only application of technical analysis that the majority of Wall Streeters are aware of as evidenced by equity research from Credit Suisse First Boston: “The question of whether technical analysis works has been a topic of contention for over three decades. Can past prices forecast future performance?” However there is another type of technical analysis that neither predicts nor forecasts. This type is based on price. Trend followers form the group of technical traders that use this type of analysis. Instead of trying to predict a market direction, their strategy is to react to the market’s movements whenever they occur. Trend followers respond to what has happened rather than anticipating what will happen. They strive to keep their strategies based on statistically validated trading rules. This enables them to focus on the market and not get emotionally involved.

Google is now in the business of following trends at their new site. Read about Google Trends here. Thanks to Jason Russell for the heads up.

Barry Ritholtz adds a great comment on his blog:

“We could merely guess – and all these calls for buying big cap tech stocks in the face of declining stock prices, decreasing P/E multiples, and rapid commoditization of their products have been nothing more than blind guesses. However, we find it is much more advantageous to wait until a given stock, sector, index or market proves itself before leaping into the fray. This is an admittedly humble approach (surprised?). We acknowledge that the future is unknown, that us Humans are particularly bad at conjecturing what lies ahead, and that most people on Wall Street refuse to acknowledge this. We confess to having no idea what the hell is going to happen even next year. Will the GOP lose control of Congress? Will bird flu kill millions? Will Iraq get even worse? And what about Katharine McPhee – can she win it all on American Idol? We own up to having no clue about any of these burning issues. And neither, we must tell you, does anyone else. So rather than merely speculate, we would rather allow a given sector to develop on its own. When we got bullish on Oil in December 2003, crude had broken out over $30, and was heading higher. Similarly, our calls on US Equities post Tax cut in 2003 wasn’t until the technical picture improved. We got bullish on Japan in 2004 when it was apparent that it had started to work; Those who were merely “guessers” had 15 years to get it wrong. Our bullishness on Gold was for similar technical reasons – after a long period of under performance it was starting to work also. Regular readers are all too familiar with our expectations for how this bull market ends – an ugly and violent death – but as long as the trend remains up, we are loathe to fight the tape and get short. Indeed, we still are not short any US equities, although we have some in the money VIX options and a few Q puts – as hedges. While we may wax eloquent and muse about what may come eventually, our investments stay on the same side of the market as the overall trend – or at worst, in cash. Once we see proof positive that a stock, sector or market has shifted direction, then we can jump in.”