Michael Covel

ROSLI HUSSIN Added:

September 23rd, 2008 at 1:31 pm

Bailouts or no bailouts, if you have a good trading strategy, you can overcome the intervention.
You have to be disciplined and believe in your trading strategy.
Do you think usd700 billion is big enough to counter the loss of usd 3 trillion in stock value.
As for trend followers they just follow. Trend followers make money when there are trends.
The golden rules “CUT LOSSES AND RIDE THE PROFIT”
We have to go back to basic. Back to trading school.

Matt - Trading System Reviews Added:

September 23rd, 2008 at 2:31 pm

How can you make a bet based on current information, when that information is turned on it’s head by a large outside force? The trends are reversed in moments, and you take horrible losses as they shift vastly in a matter of moments, you cannot cut your losses before they have gone. Stop losses are even worse as in this volatility they get taken out all over the place ensuring that you will take at least your maximum loss (with price movements like the ones we have seen will ensure that you will get filled at worse the price of your stop)
Since this intervention has been accompanied by huge volatility and volatility is the enemy of trend following. If you take volatility based position sizes it mean that you will only take tiny positions and will get whip-sawed in and out regularly racking up further (although reduced) losses. Add to this the fact that you will find it hard to find any good short candidates left, then you and your system are in a place that they have probably never been to before - the long only portfolio in a falling market.
You cannot ‘overcome’ this intervention, trend following or other system does not ‘overcome’ anything. A system should just do the right thing in the circumstances based on probability. Since this is a set of circumstances that has not come up very often, if ever, how can you know of your system can handle it? How can you know what is right as you need to understand the probabilities and we do not have enough information to determine it? The only thing you can do is endure it and hope the inevitable losses don’t take you out of the game or sit it out until the market returns to parameters that your system works in - cut the losses and ride the profit simply do not cut it in this market I am afraid.

Ladi Added:

September 23rd, 2008 at 3:47 pm

I really don’t know how a manager can take a 41% hit in a couple of days. I actually think if you do your home work well, you’ll be above the pack. Trend Following is a great system, I use it, and it’s perfect for me. However, if you have a poor portfolio selection (like trading very correlated markets) then I can see how you can be down 41%. My point is; Don’t blame the market; the market is never wrong, the trader is instead. If you are a good trend follower, I think these market conditions are extremely profitable to any trader…..IF YOU’VE BEEN RIDING IT ALL THE WAY DOWN SINCE WHENEVER THE TREND STARTED.

Ken - Todays Breakout Stocks Added:

September 23rd, 2008 at 4:53 pm

Cutting losses and riding profit works in any and all markets, always has always will. Volatility is not the enemy of anything except those who haven’t properly planned or adjusted for it. There’s more than one way to cut a loss. Using stops is one way, taking fewer positions is another. Matt if you are getting stopped out of even your tiny positions then just take fewer positions. Just keep cutting, cut, cut, cut!

ROSLI HUSSIN Added:

September 23rd, 2008 at 5:26 pm

Before the intervention, my indicator shows me to take these positions:

12 Sept.- 11422 (short)
16 Sept.- 11059 (liquidate)

16 Sept.- 11059 (long)
22 Sept.- 11016 (liquidate)

22 Sept.- (short)
Your current position now is SHORT
If you were to follow the models closely, you will not loose money or the MOTHER OF ALL LOSSES.

ROSLI HUSSIN Added:

September 23rd, 2008 at 5:30 pm

BTW, I am using the DJI as the case study.

Matt - Trading System Reviews Added:

September 24th, 2008 at 8:35 pm

All very well to say if you are shifting a few thousand dollars, try doing that with a bigger portfolio with no liquidity in the direction you need….it will not happen!

It takes a while to scale in and out of large positions you cannot just dump a large position into the market unless you want to ensure fills way below what you want.

I started trading back in ‘99 with the other ‘get rich quick’ crowd. I have learned a lot since those days and I have averaged over 30% annualized gains since then and now have a personal portfolio well north of $3 million. If I am finding it hard to get in and out of positions, think how hard those folk running billion dollar hedge funds are finding it?

I would also like to point out that I have gone from being 44% up YTD at the start of June, to 13% YTD now and I am now around 20% invested.

Everything you guys have been saying is very nice, but it shows up the issues with these models - real world slippage and liquidity makes things very different.

As you can see I have cut the number of positions, as each dropped I have not replaced them as the parameters I know my system works under have been breached, it is how my system works.

As for stops, I never use them, they do not work with larger positions sizes and are too easily exploited by scalpers.

As for riding the market down, nice idea, unfortunately you cannot do that anymore as you cannot short most of the prime candidates!!

Let me put it this way - has anyone tested their system in a market where short selling has been banned? What happens that is different? You cannot simply assume the market will behave the same if people can only make bets on the long side of the market, we all know that trends on the short side behave differently to trends on the long side, but we have no idea how it will change.

In short, this is a market where the government intervention has made the evidence used to build our systems far less relevant.

By all means keep working on your systems, but be very aware how things work in the real world and how changes to this affects you. Government intervention is something that has not occurred in recent memory, at least not on this scale.

The effects of this intervention so far has meant long term existing trends change overnight, intra-day fluctuations surge - in other words volatility is sky high. You need to be very aware how your system works and under what conditions.

Looking back to what has happened before and you will soon see that when volatility is high trend following generally gets hurt badly. I have not found a way around this, if you have, then well done, but add to this a large scale restriction on shorting and under these highly unusual circumstances are you sure your system is still good?

First rule after all is ‘Don’t lose money’ so I would rather wait for things to get back to parameters I understand or at least see what the intervention is going to be and how it will affect things before I take on any new positions.

Ken - Todays Breakout Stocks Added:

September 25th, 2008 at 12:50 am

Volatility is not the enemy of trend trading. If there’s any “enemy” its lack of trends, sideways markets. Look at the period from 1998-2003, we had massive volatility but we also had great trends. You’re saying volatility is sky high now but you are up 15% for the year, Im up for the year, most trend traders are up this year, but the market is down 20%. We are crushing the market even though volatility is high. How can that be the enemy of trend trading?

George Added:

September 25th, 2008 at 8:15 am

I think that the government should not get involved in the markets. I do not know why they should interfere. If the United States has reached the point that they can no longer remain a superpower, then it is time for them to step down and allow another country to pick up the torch and take the lead.

Throughout human history empires have risen and fallen. It is natural for empires and nations to eventually become decadent and corrupt. The United States is no exception to this rule.

Now, they have effected many people involved in the markets witch is not fair. The game of trading and investing much like the law, works when it is fair for everyone not a selected few.

I understand the comments that some people have posted here stating that it is always the trader’s fault and not that of the market when things go wrong but that rule only works when the markets work the way that they were designed. When the rules change, it is not fair to those that faithfully followed them to begin with. Where is the integrity? Where is the honor?

Sure, all things being equal, if a trader enters a trade in the market and the market functions the way that it is supposed to then it is his or her fault and full responsibility must be taken by that person but if the game is fixed what is the point!

Matt - Trading System Reviews Added:

September 25th, 2008 at 3:16 pm

Reply to Ken (mainly!)

Yep I am up on the year and very happy about it, but at every instance that volatility has been high, trends have been less profitable to trade.

I have tested it many times over and the returns are noticeably smaller when volatility goes up. The reasons for this seem to be two-fold.

The first is a matter of mechanics. If you use volatility based position sizing (which is pretty common amongst trend followers as mentioned by the good Mr Covel in Turtle Traders) position size must be reduced per position.

As a simple example using nice round figures, lets say you have a $100 000 folio and your model uses a 1% of equity at risk (or $1000). Now whatever model you use to determine volatility will give you an idea of how much the price moves around over a given time (eg 3 times the 20 day ATR or Average True Range)

So let’s say that under ‘normal’ circumstances the volatility is 10% so if we are prepared to risk $1000 and volatility is at 10% then a position can be up to $10 000 (10% of $10 000 is $1000, the amount we are prepared to have at risk) Now lets say that the volatility doubles to 20%. We still only want to risk our 1% of equity, so we can now only take up a $5000 position (as $1000 is 20% of $5000)

I use something similar for sectors too - for example I will not let my exposure to financials go over a certain amount of equity at risk. This means that if a sector becomes more volatile I will reduce my exposure to it (I tend not to close positions to make this absolutely exact, rather I let positions end naturally when the signals dictate and simply do not replace them. That is unless things get very out of whack, which happened recently with financials!)

If this occurs then you find that your overall exposure is lower to sectors that are more volatile. If all sectors are volatile, then you can find yourself less than fully invested. Naturally you can decide to put more at risk, but since the whole idea of being a systematic trader is to follow the system…..

The second issue is that you have to visualise trends as similar to a TV or radio signal. The more noise you add to a radio signal, the harder it gets to understand what is being said. Volatility has the same effect as noise to a radio signal - degrading the signal, making it harder to ’see’ the trend.

What this actually means is that during higher volatility periods you typically see the accuracy of signals drop. For example, if your system is typically 60% right and 40% wrong, you will expect to see that rate decrease with volatility, lets say to 50% right, 50% wrong. As you can see this is going to have an adverse effect on your returns.

I have also modelled how these rates change with volatility and found that losers lose more on average and winners win less as volatility increases.

So as volatility increases not only does it mean that I will be right less often, it also means that I will lose more on the wrong ones and win less on the good ones, in other words ‘ugh!’

On top of this you need to have enough data to ensure that your results are statistically meaningful. For most circumstances I have enough data to do this but quite simply I do not have enough data to give meaningful results when volatility is as high as it has been recently. However the evidence I do have is that I am getting close to merely breaking even (as the win rate drops and winners do not win as much and losers lose more….I think I might have already mentioned this!!)

Since I can achieve that with near zero risk by simply keeping money out of the market, and I am not sure of my data, I have been doing just that until I get back to a set of parameters that I know work.

Add to this the additional risk from the unknown effects of having the SEC remove the ability to short an entire market sector, the effects of the current intervention and the possible effects of any further intervention and I think that this is the only prudent action.

However if you are running a hedge fund that has to be invested by a certain percentage and with very large positions that can’t be liquidated fast, then you are going to see some nasty draw downs because of this….

Ken - Todays Breakout Stocks Added:

September 26th, 2008 at 4:03 pm

I think you’re discounting volatility that’s in the direction OF the trend. High volatility in the direction of the trend helps you, high volatility in the direction opposite the trend hurts you. But you only lose a small amount when it goes against you due to your stop. You make a lot when it’s in your direction because you just ride it. But you just cant make statements like “high volatility is bad for trends”.

>>For example, if your system is typically 60% right and >>40% wrong, you will expect to see that rate decrease with >>volatility, lets say to 50% right, 50% wrong. As you can >>see this is going to have an adverse effect on your >>returns.

This is just simply not true and goes against everything that trend following is about. Trend following systems actually get better returns as the accuracy decreases. Most trend following systems are about 30% right and 70% wrong.

Matt - Trading System Reviews Added:

September 26th, 2008 at 8:22 pm

Hi Ken,

Having read your post, I think we are talking slightly at cross purposes here. I totally agree with what you say about volatility in the direction of the trend, it’s a nice bit of juice!

Where I think we are at cross purposes is where you mention the period 98-03. You are right, this period did have higher than average volatility. However, the volatility levels I am talking about only occurred during the Asian crisis in 98 and the bottom of the bear market in 02 during that time. In both the 98 and 02 spikes, the performance of the systems I tested dropped significantly (in fact to negative) which is why I dislike the current situation which has levels similarly high!

As we know trend following is all about having a system which gives you a statistical edge. I have gone through and tested pretty much all the common versions of trend following (and before you say it, yes I am very dull!!) and every single one of them has performed worse as volatility increases beyond certain levels, as I mentioned. You either hit your stops more often or get more phantom exit signals if you exit through those instead (MA crossovers, Darvas boxes etc) Add to this your reduced position sizes and you can quickly turn a positive edge into a negative edge or at least one that does not merit trading.

Over the long run trend following will give you decent returns as we both know. My point is that if you test your system under various conditions you will be able to find where it works well and where it tends to fall down. If you do this you can then use this information to amend your position sizes, or even determine whether your edge at that time is even likely to be worthwhile trading.

You seem to take what I say as being that trend following does not work with a little volatility. My argument is simply that performance tails off badly when volatility goes beyond certain ranges. This is quite easily demonstrated by the guy mentioned in this post, my own trading performance and I am pretty sure yours over the last month or two, where the volatility has been exceptionally high.

I should point out that these periods of high volatility are rare (luckily!) and so it is very hard to get enough data to be able to draw significant results from them, but this is what I have found to be true and seems to be borne out by the current happenings.

Add to this the additional unknowns like potential bailouts, the banning of short selling for financials and the effects this will have on the trends we are trading, at least in the short term. With this and the evidence of falling performance with those high volatility levels and you have to admit it might be worth considering sitting out until things calm down and get back to ‘normal’ conditions?

Oh and lastly, the numbers you refer to in your last post were purely there to illustrate what I meant rather than be anything exact, in the same way as the 1% of a $100k portfolio example.

Matt - Trading System Reviews Added:

September 26th, 2008 at 9:25 pm

Oh and just another thing as I missed your bit on the performance gains as hit rate decreases as I think you are taking this out of context.

Indeed in some systems you do find that lower hitters work. As you say Trend following systems work because the winners are big winners and the losers small and hence the 30/70 split will give you a decent return.

However you will always be looking to optimize to achieve the best overall performance, which is achieved from the balance of the hit rate, average win amount and average loss.

So, if it turns out that using your system, you change some parameters and find your hit rate drops slightly, but your average loss drops significantly or your average win gains significantly then you will get better results. The idea is to test all your parameters to find the best compromise (without curve fitting - which is another topic) that gives you the best overall return.

However, going back to what I said in my post, if the accuracy decreases, your winners gain less and your losers lose more, then you are going to be in a worse situation there is not other way around it.

Unfortunately this is exactly what seems to happen during those pesky high volatility periods.

Fred Added:

September 27th, 2008 at 12:54 pm

One other observation ——- In my limited knowledge of trend following, isn’t the discussion of the current volatilty in the stock market a mute point? In other words, isn’t the idea to trade a diversity of markets so that there is more oppotunity to catch a trend?

Fred Added:

September 27th, 2008 at 1:00 pm

Hey Matt and Ken,
I really appreciate your posts as I am a recovering “Buy and Holder”. I just recently discovered this great web site and am determined to change my ways. I’m curious to know…..do you follow the Turtle rules in every detail; or do you create your own systems.

Here’s why I ask —– I’m very tempted to buy Michael’s course, yet I’ve gotten the message very clearly from expert traders that no system will work if you don’t follow it.

Ken - Todays Breakout Stocks Added:

September 27th, 2008 at 4:36 pm

Matt if you would just replace the words “high volatility” with “high volatility in the direction opposite of the trend” everywhere in your postings then I would mostly agree with you, haha. My research has shown that you can make more money overall in high volatility periods. The more the market moves the more money making opportunities there are. And yeah you get stopped out more and its a rough ride, but overall you make more. I mean think about it, if you want to make 100-200% gain on a stock then you’re going to have to ride out some 30-40% drawdowns along the way. The drawdowns are high volatility, but the gains are even higher volatility so overall volatility works in your favor.

And another point, I don’t think the volatility we’ve seen recently is that unusual. Its pretty much the same as we saw back in march and january.

Matt - Trading System Reviews Added:

September 29th, 2008 at 9:50 am

So you regularly get 30-40% draw downs, enough said…..!

The whole point of this article was about the bizarre and unprecedented draw-downs being seen by experienced traders recently.

If you are seeing draw-downs around 40%, then your trading is far too aggressive. It’s like overtaking on blind corners, it works fantastically right up until the first time it fails.

I would honestly suggest you go and read up a lot more on risk management. If these good and experienced traders are seeing abnormally large draw downs then you should be very worried.

All it will take is one of those large moves to go against you and, since you normally see large draw-downs, you will be pretty much wiped out. Even if you are not wiped out a 50% draw down means you have to get a 100% gain to get back to where you started. A 75% draw-down and you need a 400% gain to get back to where you started.

Just because this hasn’t happened yet does not mean that it won’t. This argument follows a similar thought process to one that says every day you live is further proof you are immortal. In fact it’s the same thinking that has crippled the banks….

Your comment about this volatility not being unusual also demonstrates this. Your view of historical volatility only goes back to the beginning of the year!

I realize you are almost certainly not going to agree with what I have said, so I’m not going to write any more on this post unless something interesting comes up. This post is getting very long now and I think everything has basically been said and I’m not a fan of banging my head against brick walls.

Ken - Todays Breakout Stocks Added:

September 29th, 2008 at 8:37 pm

Im not worried at all, you’re the one getting slapped around in the market not me. I never said I had 40% drawdowns, I was just giving an example of how risk and reward go hand in hand. You say my view of historical volatility only goes back only to the beginning of the year, huh? Didnt I refer to 1998-2003 period when talking about high volatility?? Pull up a 10yr chart of the market. How can you say historically this volatility is unprecendented? Have you done any system testing more than 5yrs back?

The bottom line is this: Trends exist in volatile markets, trends exist in non-volatile markets. Do not be afraid of volatility, simply adjust to it. And use good money management techniques to ride through the rough periods of losing streaks. In the long run, volatility is good. Volatility is just market movement. If markets didn’t move we wouldn’t make money!

Ken - Todays Breakout Stocks Added:

September 29th, 2008 at 10:31 pm

Also the point of the article was not drawdowns. The point was that people are losing faith in the markets due to govt intervention. If they feel the game is rigged then they will stop trading. Drawdowns are a normal part of trend trading. Also the trader the old pro trader was referring to had 5yrs trading experience, and in that time period the market is up 50%. How you could consider that an “experienced” trader is beyond me.

Ken - Todays Breakout Stocks Added:

October 1st, 2008 at 10:19 am

And one more thing, just because one stock drops 40% doesn’t mean someone’s portfolio is down 40%. Actually it doesn’t mean anything, if someone is using a 50% retracement stop then they wont even get stopped out on a 40% drawdown. And if they do get stopped out and are using a 1% equity stop then they only lose 1% of equity. You could have a string of 10 stocks that drop 40% and still only lose 10% of your equity. So again, the key is to adjust for volatility.

Matt - Trading System Reviews Added:

October 1st, 2008 at 7:52 pm

Hi Fred,

In answer to your question mine is not based on the Turtles. I have been through and tested breakout based systems and I have found other indicators, risk management etc better as there are many derivations on the trend following theme.

The other thing is that it is very hard to trade someone else’s system. If you devise one, test it, get aware of it’s limitations, understand it’s levers etc, then you are far more likely to trust it and do what it says - discretion is not part of the game, discipline is!

If you are looking to get into this seriously I would suggest that you read Van K Tharp’s book ‘Trade your way to financial freedom’ While not perfect (the title is enough to put you off!) it does give a good primer on what you need to consider when devising a system.

Next go and get some kind of software to test your theories (wealth lab, trade station etc) and expect a lot of hard work. Keep reading and experimenting and you will find something that works and you can trade (again the psychological elements are far more important than most people credit as you need to keep going through the tough times)

Hope that helps

Matt - Trading System Reviews Added:

October 2nd, 2008 at 1:12 am

OK last go banging my head against a brick wall….

Firstly, the draw downs are exactly what this article is about, they were caused by the intervention. If government intervention caused traders to make money do you think they would stop trading saying the markets are corrupt?

As for unprecedented volatility, VIX has recently hit an all time high by some margin….but for you this still seems normal?

My data goes back to the 1980s and yes I have tested it back to then through the 1987 crash etc. and not many periods have volatility this high I can assure you. There are periods where certain groups of stocks have got very high volatility but not this widespread.

From your post it sounded like you were implying that your portfolio got 30-40% draw downs chasing those 100%+ individual gains. Thinking about it though, if you have a hit rate of around 30% (as you stated above) and a stop of around 50% on each that loses then it still sounds about right…

On the position sizing point, I already mentioned I use volatility based positions sizes too, don’t know too many folk that don’t with any kind of trend following system.

This also demonstrates why one reason why volatility does have negative effects on returns.

As an example, assuming that as volatility increases you reduce your position sizes. Now let us assume we have a 100k portfolio. Also lets say we were taking 10k positions under normal circumstances and when volatility is high you take 5k positions (numbers are here purely to illustrate a point, not supposed to be what you would actually trade before you pull that one up again)

Lets also assume that on average you make 100% on a trade (yes it’s illustrative too…) So when it’s volatile then you only make 5k as opposed to 10k. This means 5% rather than 10% on your overall portfolio on an average trade.

So to make the same overall return on your portfolio you would need to take twice as many positions in this instance.

As we know trends do not turn up to order, you are often sitting around waiting for them (there is even that bit in the Turtle Trader book where they talk about how much table tennis they played while waiting!)

If you are unable to find any other trends to put your money in, then you are going to be making smaller overall returns in volatile markets as you will often not be fully invested.

There are other reasons why you also lose more on your losers and gain less on your winners in volatile markets too, but it would take far too long to explain and I doubt you would read it anyway

(if anyone wants me to post this just let me know)

As for volatility being market movement - it is in the same way as giving your granny speed gets her moving; she gets very excited and unpredictable but doesn’t go too far!!

Now if you put your granny at the top of a hill and pushed her wheelchair down it, then that’s a nice downward trend…

Ken - Todays Breakout Stocks Added:

October 2nd, 2008 at 5:50 pm

Take a look at a 15-yr chart of the VIX (you can find it on yahoo finance). How can you look at that chart and honestly say the volatility we’re seeing today is “unprecedented”?? If your system is based on 15yrs or more of data then todays high volatility should have been factored into your trading already because we’ve seen it many times before!

And while you’re looking at that chart, you’ll also notice that when the volatility was high, we had great trends in the market. When the volatilty was relatively low, the market went sideways, non-trending. Look how high the volatility was from 1998-2003, did we have large trends or small trends then? Todays volatility is high, do we have large trends or small trends? The answers are easy! And you, I, and most trend traders are crushing the market this year in a high volatility environment. With all that data, how can you still persist in your belief that “high volatility is an enemy of trend trading”?? Ive done 50yrs of backtesting and Ive seen no evidence of that.

Ken - Todays Breakout Stocks Added:

October 2nd, 2008 at 11:06 pm

Well if you correctly comprehended what I said and what Michael said then you would save yourself alot of headbanging (and typing!). Michael says very clearly “The issue is one of trust”. Thats the issue! Its not drawdowns! The old pro trader mentioned drawdowns, not Michael.

You say the drawdowns were caused by the intervention. Were they really? You are not responsible for your drawdowns? The drawndowns had NOTHING to do with your system?

Ken - Todays Breakout Stocks Added:

October 7th, 2008 at 12:12 am

And look at the VIX today! It hit 56, far above its old high of around 46. And today was a massive down day, a huge downtrend. This was sky-high volatility and yet an incredibly strong trend. Was high volatility the “enemy” of this trend?? I dont think so! If this doesn’t convince you that volatility is not an “enemy” of trends then I dont know what will!

Edward Brode Added:

October 10th, 2008 at 11:04 am

Volatility Schmolatility. Look at the currency markets. If you need liquidity on large amounts of money, trade FOREX, Trend following works on currencies very well, I’m riding the USD/CAD, now, and it is up 435 PIPs. My trail is 80 PIPs, so my profit is locked in.

If you don’t have the software to automate it like I don’t, create a spreadsheet of the last 20 day’s data on a few (it is a lot of work) currency pairs that are not correlated and update it every day to see short or long signals. A macro can change the running ATRs, etc daily.