From NY Times:

Mutual funds are run by highly experienced and hard-working professionals who buy and sell stocks to achieve the best possible results for their clients. Nevertheless, the evidence from more than 50 years of research is conclusive: for a large majority of fund managers, the selection of stocks is more like rolling dice than like playing poker. At least two out of every three mutual funds underperform the overall market in any given year.

That’s but one great nugget. Read it.

Note: Shout to Ritholtz.com for the article find.

If you have not had a chance to see my new book The Little Book of Trading, check it out. It is filled with trend following insights across traders with decades of experience.

From IBD:

Shell: The exit, not the entry, is what actually creates the results. That is, many people talk about what to buy, but we can’t control the outcome at the point of buying an investment. The outcome is instead determined by what price you sell at. When we buy something, we don’t know in advance if it will be a profit or loss or how much it will win or lose. The result will depend on at what point you sell it.

IBD: How often do you rebalance or reconstitute your portfolio?

Shell: That’s a good question and allows me to make an important point. Rebalance is an asset-allocation term. Rebalance means to restore balance to something. Asset allocation, then, means to put money in a certain place and then maintain a fixed amount there. Since the allocation itself is static, they rebalance to maintain the static allocation. That is, they sell things that are going up and add to things that are going down to maintain their asset allocation. They seek balance.

I seek imbalance, which is why we use what we call the Asymmetry Investment Program. Asymmetry means imbalance: We want imbalance between our risk and reward. We seek more reward than risk. If you balance risk and reward, your portfolio will have periods of gains followed by periods of losses with no real upward progress. The only way to achieve upward progress is the process of asymmetric returns: when your total return exceeds your downside risk.

In pursuit of Asymmetry, we rotate between ETFs invested in cash, currency, bonds, stocks or commodities instead of having a fixed allocation to them. The rotation is in direct response to market conditions. For example, a rotation from stocks to cash would be in response to falling stocks. A rotation into bonds from stocks would be in response to bonds trending up and stocks trending down. It’s a process that dynamically adapts to changing market conditions instead of an arbitrary static allocation based on a fallible prediction of expected return.

Major media dipping their toes in?

David Rosenberg writes:

…we are still living in a world were levering up is somehow deemed to be a solution to a world of excessive credit and all this will do, again, is just kick the can down the road. Unfortunately, post-Lehman the concept of cramming down debt holders to arrive at a more sound financial position has been thrown out the window. Causing pain to bond-holders or equity holders is a sin right now, believe it or not. There will be a price to be paid down the road for failing to allow bad risky decisions to be penalized. Instead we paper over our issues with QE and financial engineering that may make things worse down the road.

It is truly hard to believe that a Greek default could produce any worse results than what we have already seen from all these bailout attempts. This too-big, or too-important to fail strategy has got to come to an end if we are ever to fully emerge from this increasingly unstable global debt cycle.

How could fundamental analysis possibly be used to make money from this kind of financial voodoo environment?

Candace Czernicki writes:

A recent study published in Social Psychological and Personality Science shows that people who experience seasonal depression shun financial risk-taking during seasons with diminished daylight but are more willing to accept risk in spring and summer. “We’ve never, until now, been able to tie a pervasive market-wide seasonal phenomenon to individual investors’ emotions,” says Prof. Kramer, who teaches behavioral finance at the University of Toronto’s Rotman School of Management.

The article adds:

“So much common wisdom about economics and finance is built on the notion that we’re very rational about making financial decisions,” says Prof. Kramer. “But increasingly we’re discovering financial decision-making is an inherently emotional process.”

Solution? Trend following. Bet you did not expect me to say that?

Malcolm Gladwell writes:

Insurgents work harder than Goliath. But their other advantage is that they will do what is “socially horrifying”—they will challenge the conventions about how battles are supposed to be fought. All the things that distinguish the ideal basketball player are acts of skill and coordination. When the game becomes about effort over ability, it becomes unrecognizable—a shocking mixture of broken plays and flailing limbs and usually competent players panicking and throwing the ball out of bounds. You have to be outside the establishment—a foreigner new to the game or a skinny kid from New York at the end of the bench—to have the audacity to play it that way. George Washington couldn’t do it. His dream, before the war, was to be a British Army officer, finely turned out in a red coat and brass buttons. He found the guerrillas who had served the American Revolution so well to be “an exceeding dirty and nasty people.” He couldn’t fight the establishment, because he was the establishment.

Nice.

My documentary film’s name, Broke: The New American Dream, is derived straight away from Ed Seykota’s line in the book Market Wizards:

“Win or lose, everybody gets what they want out of the market. Some people seem to like to lose, so they win by losing money.”

Film site: www.brokemovie.com. More film info.

From the NY Times:

No wonder Occupy Wall Street took its protest this week to East 86th Street and the 28,500-square-foot limestone mansion owned by the billionaire hedge fund manager John A. Paulson. What better symbol of the excesses of Wall Street than Mr. Paulson, who made billions betting on the real estate collapse and whose opulent surroundings stand in such contrast to the million of Americans who have lost their homes?

Mr. Paulson made more than $15 billion for his hedge funds by betting on the collapse of the mortgage-backed securities market in 2007 and 2008, then followed up with an equally well-timed bet that large banks would survive the financial crisis and that the price of gold would soar. Last year he personally earned what has been estimated as the largest single payday in Wall Street history: $4.9 billion.

It continues:

This week Mr. Paulson reported his results through the third quarter, which ended Sept. 30. His flagship Advantage Plus and Advantage funds were down 47 percent and 32 percent. His Recovery Fund was down 31 percent. His once high-flying gold fund lost 16 percent in September, cutting its gains this year to just 1 percent.

And concludes:

What’s surprising isn’t that Mr. Paulson’s returns have crashed to earth, or even that his reasoning this year has so far proved so spectacularly and consistently wrong. It’s that in lionizing Mr. Paulson and handing their money over to him, so many people succumbed to the enduring myth of the financial genius, ignoring the boilerplate that appears on every prospectus: “Past results are no guarantee of future returns.”

Few things:

1. Why should I care how much money Paulson made if he made it legally? Why does anyone care? Jealousy, is that it?
2. That last sentence about past results? THAT is what makes trend following so attractive. There are trend following proxies, professional winners, going back decades. Trend following is not the result of one big bet in some random year. No, it is a process of trading, a strategy, that has stood the test of time.

A friend of mine passed this piece along courtesy of her friend a prominent vascular surgeon living in Washington, DC:

In reading about Steve Jobs’ death, I was disappointed to learn that after his carcinoid tumor (a rare type of malignant tumor) of the pancreas was diagnosed, he waited nine months before having it removed because he believed that a strict change in diet would cure the problem. This raises the issue of risk analysis, a hard and sometimes controversial topic that, blessedly, doesn’t seem to be a Republican or a Democratic issue. Nonetheless, while this topic is difficult to understand in depth, it is, in my view, well worth spending some time contemplating. For, as most of you undoubtedly know, risk assessment is at the heart of economics, banking, horseracing, investments, medicine, agriculture, baseball and public policy to name just a few.

There is a wonderful book entitled: “Against the Gods, the Remarkable Story of Risk” by Peter Bernstein. At a minimum, have it on your bookshelf and peruse it periodically. One interesting point is that there is an amazing asymmetry as to how we make decisions with regard to gains and losses (pages 272 forward). When decisions involve the possibility of considerable gains, we are consistently risk-adverse (i.e., we will opt for a sure gain versus an even greater gain with the possibility of no gain). In contrast, when the choice involves losses, we are risk seekers, not risk-adverse (i.e., we would rather take an 80% chance of losing $4000 and a 20% chance of breaking even than accepting a 100% chance of losing $3000).

On the surface this may seem like an interesting conundrum but one which has little relevance to our day-to-day lives. In general, I think this is correct. But not always. The term “conventional wisdom” has acquired, in many cases justifiably, a patina of being pejorative. Ordinarily, one would think that conventional wisdom was for the most part based on experience (also known as “data”). Given the increasing focus within health care and policy making to have decision-making be driven by data (“evidence-based”), it seems reasonable to be supportive of this concept while keeping in mind that close calls can be skewed one way or another by how the statistics are formulated or interpreted.

But analysis of a large amount of conventional thinking seems to me to reveal that in most cases the conventional wisdom is entirely correct and in a few notable cases conventional wisdom falls far short (that is, most of the time it’s not a close call as to whether the perceived understanding is credible upon close inspection). As a notable example, we all know that eating a meal diverts blood supply to the intestines and thus vigorous exercise such as swimming immediately after a meal will divert blood supply away from leg muscles and cramps will occur such that a large number of children will drown if they go swimming soon after eating lunch. How do we know this? Our mothers told us so. The confirmatory data supporting this hypothesis are the many dead children who must be removed from pools in the early afternoon each summer. It is because of a number of instances of such ludicrous and loose thinking that for more than 50 years we have frequently succumbed to the notion that most established dogma should and can be subjected to criticism and thus often be dismissed immediately. My suggestion is that when you are inclined to do this, do so because you have acquired believable and reproducible data from reliable sources that support your opinion and reliably debunks conventional wisdom. Absent reliable data, think twice when you are inclined to summarily reject conventional wisdom. Remember the adage “everyone is entitled to his own opinion, but not his own facts”.

My plea therefore, is that we try to train ourselves and our children as well as our friends, when appropriate, to be aware of the need to make ourselves make important decisions based on reliable data rather than whim or opinion not well grounded.

This brings us back to Mr. Jobs. My speculation, based on what I have read thus far, is that he viewed much of his phenomenal success as being a result of his amazing ability to confront and overturn conventional wisdom. I suspect he assumed his extraordinary talent in this one facet of life translated into a belief that he was equally talented in other arenas where he had little training or experience (I have been astounded through the years at what poor health care decisions truly rich people make–I guess it’s called “regression to the mean”). So, when Mr. Jobs made the decision that he could cure the carcinoid cancer that he knew he had (biopsy confirmed) with diet, he did so with not one scintilla of believable data. To my knowledge there has never been a case of carcinoid tumor cured by diet. Of course, we have to keep in mind that a prompt operation might not have been curative. Unfortunately, for him as well as for us, we’ll never know.

Thanks. And I am a huge Jobs fan.

Note Added Oct 20: The Associated Press purchased a copy of the book Thursday. The book delves into Jobs’ decision to delay surgery for nine months after learning in October 2003 that he had a neuroendocrine tumor — a relatively rare type of pancreatic cancer that normally grows more slowly and is therefore more treatable. Instead, he tried a vegan diet, acupuncture, herbal remedies and other treatments he found online, and even consulted a psychic. He also was influenced by a doctor who ran a clinic that advised juice fasts, bowel cleansings and other unproven approaches, the book says, before finally having surgery in July 2004. Isaacson, quoting Jobs, writes in the book: “`I really didn’t want them to open up my body, so I tried to see if a few other things would work,’ he told me years later with a hint of regret.”