Michael Covel is the author of the internationally bestselling book Trend Following

In Search of the Grail

January 31, 2005

A reader writes:

"Why don't you give customers what they want? They want to know what trend the market is right now. You tell them that and you'll get and keep so many more customers. I write and publish a newsletter myself and each day I stick my neck on the line to say what is happening in the market and whether or not the action is healthy (safe to invest long) or unhealthy (move into cash/short)."

This is the exact same mindset that ran crazy during the dot com bubble. I thought they were all dead and buried, but they live on to fight another day! All readers here should see the huge downfall to this man's desire.

Trend Following Interviews

January 30, 2005

Just finished a trip to London. I interviewed three notables in the industry. One trader has a 15+ year track record and now manages over $1 billion USD trading as a trend follower. Before that number seems large (and it is) keep in mind that he was a one-man business but a few years ago. Another trader is relatively new to the public world and still runs a small and lean shop. He uses only the closing price each day and competes just fine with less data. Lastly, I spoke candidly with a professor who has written extensively on the subject of trend following trading. He agrees with me that to some degree many academics will have a hard time ever acknowledging the existence of trend following as it upsets the carefully crafted "efficient markets" foundation upon which they rest their reputations.

Warren Buffett

January 29, 2005

CNBC Transcript of Jan. 19, 2005, interview with Warren Buffett:

BILL GRIFFETH: I know I'm not going to get you to tell us what you're buying or anything, right now, but your thoughts on the stock market right now in light of what's going on with the economy and corporate profitability, the Fed raising rates? I mean, just big picture, what's Warren Buffet think of the U.S. stock market right now?

BUFFETT: Well, I certainly welcome the chance to buy businesses, or for that matter, stocks, denominated in the other currencies, or businesses that do -- make their money in other currencies. But I've always been interested in that. But I would say that it would be a small plus to be in half a dozen other countries versus earning money in the dollar. We still have most of our money in dollars. That's the nature of running all the businesses we do. But we've never -- prior to 2002, I had never owned a dime's worth of foreign currency. I mean, when I got back from a trip, I couldn't wait to cash in my eight euros, or whatever is was that was left over. But I've changed my views.

Curious minds want to know when and how Buffett would reverse his opinion on the dollar. Since buying and holding currencies is not exactly a strategy, what is Buffett's currency trading strategy?

End of Day Prices

January 28, 2005

Even with trend following trading many people still fixate on watching prices during the day. However, if you are trading as a trend follower for your own account there is no reason you can't use end of day prices for your trading. That means you can focus on making your trading decisions off one price each day.

Japanese Version

January 27, 2005

Japanese version of Trend Following.

James Altucher on Trend Following

January 25, 2005

James Altucher wrote an article (PDF) in The Financial Times yesterday. It is worth noting that Altucher first thanks Victor Niederhoffer in his most recent book.

Complete Hype. Ug.

January 23, 2005

Here is a very sad example of complete nonsense. Traders who believe this deserve what they get.

TransTrend's Principles

January 22, 2005

TransTrend, a Dutch-based trend follower, spells out their views on "robustness" and "systematic" trading:

"TRANSTREND considers a high degree of robustness to be essential. With regard to the design process of trading systems, this has led to three fundamental principles:

TRANSTREND's trading systems are not models. They do not attempt to forecast fair values or equilibrium price levels, and they are not based on an economic theory that risks becoming out-dated. Systems are dynamic and reactive by nature, they respond to changes in a consistent way."

Wrong Place to Blame

January 21, 2005

I made the point in my book Trend Following that traders are not to blame for price trends. Great traders follow trends. They don't generate them.

Along those lines a good excerpt from Peter C. Fusaro and Gary M. Vasey:

"...don't blame the hedge funds. They are only a sign of a woefully under-invested energy market that has suffered neglect for decades. They are true trend followers and they are attracted by tightening supply/demand along with ongoing potential disruption through terrorism and other unforeseen events. Contrary to what you may read elsewhere, they aren't the underlying cause of rising energy prices. The hedge funds see the writing on the wall as a result of the lack of real investment in the energy complex combined with increasing demand. And this is at a time when their traditional alternative investment strategies and markets haven't performed well. They are armed with ever increasing amounts of investor's cash looking for a market...the recriminations have already started with various politicians and energy industry figures crying "foul." By placing the blame for raising energy prices on "speculators" and "profiteers," the public's attention is drawn away from the real issue a sustained lack of investment in energy industry infrastructure. Yes, it's true that hedge funds and investment banks seek to make a profit in the energy industry. In fact, this influx of cash is a good thing for liquidity and for the energy companies that need access to capital. Yes, it is true that speculation tends to magnify an existing trend somewhat by helping to accentuate that trend but no, speculation is not the underlying reason for rising energy prices. It is clearly market fundamentals of supply and demand and an aging energy infrastructure that is the basis for the trend."

"Prediction Markets"

January 19, 2005

Chris F. Masse has put together some great links in the field of "prediction markets". I am the first to admit this use of the term "prediction" is misleading. It reminds me of the term "managed futures". Everyone uses it even if it is confusing. The action on these new exchanges is about following the trend, not predicting it.

Hedgestreet.com, mentioned fondly by Chris above, continues to innovate. They have added silver now.

Profit from Increased Volatility

January 18, 2005

A good read (PDF) from trend follower Eclipse Capital.

30 Year Track Record

January 16, 2005

Sometimes an image can create an "aha" moment:

View 30 Year Track Record

Pull out your HP 12C calculators and do some compounding comparisons with that chart.

Hot Tip Bunk

January 15, 2005

Here is a great example of the hype all people should avoid:

***

THIS COMPANY IS GETTING READY TO EXPLODE

DON'T LET THE WIND PASS YOU BY ON THIS ONE!

David Harding on Risk

January 13, 2005

The following excerpt is from an interview with David Harding, Managing Director, Winton Capital Management. David's firm is primarily trend following based.

HedgeWeek: Are institutional investors prepared to take more risk for higher returns?

David Harding: Sadly, the institutional investors and the consultants who service them are doomed forever to make the same mistakes, they all want results with zero risk. Futures fund management, and hedge fund management in general, is not a traditional asset management business – it is a risk management business. An investor should be hiring us to take risk on their behalf, and we will take exactly the level of risk that they ask for. For example, if an investor has USD 10 million and asks us to produce annual variance of 1 per cent on that, we will do it and we will get it exactly right. In contrast, returns are not predictable!

Gann Hype Continues

January 12, 2005

A recent opinion on my book said it was good for perhaps the "experienced Gann trader" looking for a new approach. There is a problem with this logic. There is no such thing as an experienced or profitable Gann trader.

A good excerpt on Gann foolishness:

"At heart, Gann's advanced methods are essentially numerology. Numbers drawn around a "magic square" and various geometrical lines drawn on charts called "Gann Fans" which are drawn at numerologically important angles, cycles, "Gann numbers", astrology, biblical predictions and even the Great Pyramid of Cheops are part of his wide variety of techniques. Many of these techniques originally worked with little gadgets that mechanically calculated these "important" numbers. Little wheels and puzzles, you would dial up the present market levels in it and the pointer would show the various Gann numbers as output. To the best of my knowledge this represents the first historically documented case of a professional trading guru marketing a dodgy black box trading package. The workings of these devices was obvious enough, you would turn the dial and there is the answer, however how Gann never came up with any sort of evidence as to how he found his algorithms, he seems to be the L. Ron Hubbard of futures trading, presenting his "research" as a fait accompli and never subjecting it to any form of scrutiny."

Price Momentum

January 11, 2005

Price momentum in futures markets was analyzed in a recent paper. In the conclusion wise points were raised regarding hedgers:

"The trend-following profits we document are unlikely to be explainable by known risk factors, and are too large to be subsumed by the relatively low transactions costs in futures markets. Our results incorporating past trading volume show that, unlike in the stock market, volume adds little information; that is, when we control for past return momentum, there generally are no significant differences in the realized returns of high vs. low volume commodities. However, when we examine the temporal relations between net long positions by trader type and trading rule indicators, some very interesting findings emerge. We find strong evidence that, in most futures markets, commercial traders are contrarians, and that non-commercial traders use trend-following strategies in the aggregate. While the latter finding was expected, given the prevalence of managed futures funds and commodity pools among reporting noncommercial traders during the 1986-2003 period, the stylized fact that in most markets it is the commercial traders (and not, for the most part, the non-reporting traders) that are contrarians in the aggregate is surprising. While these findings suggest that momentum profits are being driven by hedging pressure, it is not immediately obvious why these large, presumably knowledgeable commercial traders are employing contrarian trading strategies when these strategies are unprofitable on average. Are they rationally reducing their risk in some way by doing so? Or are commercial traders contrarians because they are succumbing to behavioral biases such as loss aversion and/or the tendency to lock-in favorable commodity prices too soon?"
Qian Shen
Department of Economics
Alabama A&M University

Andrew C. Szakmary
Department of Finance
University of Richmond

Subhash C. Sharma
Department of Economics
Southern Illinois University at Carbondale

Dilbert

January 10, 2005

Catch as Catch Can

January 09, 2005

Trend following trading can be seen in nature. The predatory nature of a trend following strategy resembles that of a Great White:

"Just as each of us must balance a household budget, predators must balance an energy budget. All of the multitudinous tasks that an organism needs to carry out in order to maintain itself must be accomplished within its energy budget. Everything an animal does is limited by the number of calories it takes in. Thus, it doesn't make sense for a predator to expend more calories in capturing a prey animal than can be extracted by digesting it. Predators - unlike nations - cannot operate at a deficit, at least not for very long. How do predators decide how to best expend their calories? Do they strive to 'economize' - minimize energy expenditures and maximize energy 'profits'? Why, from a group of similar potential prey organisms, does a predator choose one individual prey animal over another?...There is ample evidence from field studies that predators tend to be opportunistic, but it is a gross oversimplification to suggest that they rely on prey that are sick, injured, or just plain stupid. There are very few 'free lunches' in nature...[and] evidence suggests that the White Shark is a cautious and methodical predator that feeds relatively infrequently."

Reversals

January 07, 2005

All the volatility in currencies this week was not good for trend followers. But then again, trend followers aim to capture the "meat" of a trend. Trend followers don't time tops or pick bottoms. If you ever see a trend follower bragging he "timed a top", question him or her. There is a high degree of probability that individual is not trading as a true systematic trend follower.

Here is a good example of the wrong way to think:

"Exit longs on the exact day of the historic high!"

This is not the talk of a great trend follower.

Not Trend Following

January 05, 2005

It is a challenge to bring new traders over to a trend following mindset, but it is doubly hard when wrong information on trend following is put forth.

Trend following trading does NOT involve:

1.) Trading spreads.
2.) Profit targets.
3.) Swing trading.

Most all great trend followers are trading the same approaches they were trading 20 years ago. They don't worry about changing markets as all good trend following systems are built from the ground up to respond to change from the start. Responding to change is inherent in trend following.

If you ever see someone say that trend followers have changed to new styles (and I do see this), realize they are dead wrong.

Krispy Kreme Down for the Count

A few years back everyone was projected to eat 600 Krispy Kreme donuts per day. The stock then started racing to the moon straight up. As the stock soared you could have ridden the trend as a trend follower or as a fundamental trader. For a trend follower it was easy -- nice trend, get on board and see how far it can go -- but always have the exit plan. The fundamental guys got on too since there were so many rosy projections about increased donut consumption, but as usual they had NO exit strategy.

Looks like the proverbial sh** has hit the fan:

"Krispy Kreme (KKD) shares tumbled 15% Tuesday after the company announced it would restate its 2004 earnings and admitted that it was in violation of credit agreements with its primary bank lenders. The announcement was the latest in a string of negative surprises that have dribbled from the North Carolina doughnut maker in the past year. Krispy Kreme since it went public in April 2000. The Securities and Exchange Commission has opened a formal investigation into Krispy Kreme's accounting practices, and the company disclosed its first-ever quarterly loss last May. Its share price--which closed at $10.48 on Tuesday--is down almost 80% from its high near $50 in 2003. Questions about its accounting for purchases of franchise stores have tarnished a success story built on doughnuts with a fadlike popularity and earnings statements pointing to robust growth. "Those numbers they gave investors are melting away as fast as one of their doughnuts in your mouth," says Lynn Turner, former chief accountant of the SEC. John Ivankoe, an analyst who follows the stock for J.P. Morgan Securities, maintained his "underweight" rating--the equivalent of a sell recommendation. "We believe the stock is substantially overvalued," he said in a new report."
Greg Farrell, USA TODAY
January 5, 2005

Question. When did the Krispy Kreme down trend begin? Look at the chart. It did not go from 50 to 9 in one day. I am sure many will yell they were duped by illegal accounting practices and blame such for their losses, but wasn't the stock price telling you well in advance there was a problem?

Krispy Kreme is another great example for illustrating the alternative of trend following trading. If you bought and held this baby, well, ouch.

Technical & Fundamental Analysis

January 04, 2005

One of the missions of my book was to help to clarify the differences in various forms of technical analysis. While many so-called technical analysts use it to "predict" the market, technically-based trend followers only react to the market. They react to price movement and ride trends. There is no prediction involved with trend following trading. Perhaps some feel I am splitting hairs on these differences in technical analysis -- they are missing a big point.

A bigger confusion, however, appears to be in the minds of those that attempt in some fashion to combine both technical and fundamental analysis. How does one do this? Where are the track records of traders that combine these drastically different market views? It might sound good at a cocktail party, "I use both technical and fundamental analysis" -- but how is this achieved?

Jim Rogers New Book

January 03, 2005

Jim Rogers has a new book out called Hot Commodities. Jim is a fundamental trader and he makes clear on p. 93 that is not so sure about technical analysis. If he is talking of the predictive type of technical analysis, I agree whole-heartedly with him. Prediction is folly -- especially in the hands of the technical indicator gurus.

Earlier in his book though, he directs potential investors in commodity markets to seek out "commodity pool operators" (CPOs). I hate the term commodity pool operator. It is a governmental term slapped on traders regulated by the CFTC. It does not accurately describe the nature of these traders. For one thing most commodity pool operators are technical trend followers and most trade in much more than just commodities. I seriously doubt you can find a CPO today that trades ONLY in commodities. The term commodity pool operator is plain misleading. Not picking on Jim for using it, but I am picking on the term itself.

Even though Jim is a fundamental guy I have always admired his understandings of the world. There can't be many out there who can connect all those fundamental dots like Jim -- and make money too. Plus he is telling the world that commodities are worthwhile markets too!

Logic & Fallacies

From Jeff Lowder, some good logic defintions:

Shifting the Burden of Proof

The burden of proof is always on the person asserting something. Shifting the burden of proof, a special case of Argumentum ad Ignorantiam, is the fallacy of putting the burden of proof on the person who denies or questions the assertion. The source of the fallacy is the assumption that something is true unless proven otherwise.

"OK, so if you don't think the grey aliens have gained control of the US government, can you prove it?"

Red Herring

This fallacy is committed when someone introduces irrelevant material to the issue being discussed, so that everyone's attention is diverted away from the points made, towards a different conclusion.

"You may claim that the death penalty is an ineffective deterrent against crime -- but what about the victims of crime? How do you think surviving family members feel when they see the man who murdered their son kept in prison at their expense? Is it right that they should pay for their son's murderer to be fed and housed?"

Plurium interrogationum (Many questions)

This fallacy occurs when someone demands a simple (or simplistic) answer to a complex question.

"Are higher taxes an impediment to business or not? Yes or no?"

Argumentum ad Novitatem

This is the opposite of the Argumentum ad Antiquitatem; it's the fallacy of asserting that something is better or more correct simply because it is new, or newer than something else.

"BeOS is a far better choice of operating system than OpenStep, as it has a much newer design."

Argumentum ad Nauseam

This is the incorrect belief that an assertion is more likely to be true, or is more likely to be accepted as true, the more often it is heard. So an Argumentum ad Nauseam is one that employs constant repetition in asserting something; saying the same thing over and over again until you're sick of hearing it.

On Usenet, your argument is often less likely to be heard if you repeat it over and over again, as people will tend to put you in their kill files.

Argumentum ad Ignorantiam

Argumentum ad ignorantiam means "argument from ignorance." The fallacy occurs when it's argued that something must be true, simply because it hasn't been proved false. Or, equivalently, when it is argued that something must be false because it hasn't been proved true.

Here are a couple of examples:

"Of course the Bible is true. Nobody can prove otherwise."

"Of course telepathy and other psychic phenomena do not exist. Nobody has shown any proof that they are real."

Argumentum ad Crumenam

The fallacy of believing that money is a criterion of correctness; that those with more money are more likely to be right. The opposite of Argumentum ad Lazarum. Example:

"Microsoft software is undoubtedly superior; why else would Bill Gates have got so rich?"

Argumentum ad Numerum

This fallacy is closely related to the argumentum ad populum. It consists of asserting that the more people who support or believe a proposition, the more likely it is that that proposition is correct. For example:

"The vast majority of people in this country believe that capital punishment has a noticeable deterrent effect. To suggest that it doesn't in the face of so much evidence is ridiculous."

"All I'm saying is that thousands of people believe in pyramid power, so there must be something to it."

Straw Man

The straw man fallacy is when you misrepresent someone else's position so that it can be attacked more easily, knock down that misrepresented position, then conclude that the original position has been demolished. It's a fallacy because it fails to deal with the actual arguments that have been made.

Still Searching for Understanding

January 02, 2005

I received a very nice email the other day. This trader heaped praise on my book Trend Following and thanked me for writing it. He then asked what the dollar forecast was for 2005.

It does make you scratch your head. Why would he ask this after reading a book about trend following? I don't think this guy is alone in his confusion. The question becomes, "how can one bring trend following understanding to newbies?" And don't think for a second I use the term newbie as a slight. I have come across some extremely bright people who have never heard of trend following, or never considered it or refuse to believe it is possible. All of those people are newbies.

Invest Like Harvard

January 01, 2005

How To Invest Like Harvard. There's "not much plain vanilla" in the university's portfolio.

Ric Edelman Blows Hot Air

Ric Edelman hosts a radio show on personal finance. Today he reminded listeners of his "prediction" back in October 04 before the election. "Everything will work out right as long as you stay in the stock market." He went on to say in effect, "My October prediction was right and the market went up +10%." He then said the only people that made money in 04 were those fully invested in 03 & 04 since those would have been the only people in position to catch the post-election rally. Enough! By this logic those that have been buying and holding the Nasdaq since spring 2000 should just sit still and wait for the Nasdaq to get back to 5000. Edelman talks to people as if they are incapable of imagining anything beyond buy and hold.

The Edelmans of the world call trend following "gambling". Rather than dig in and learn what it is, they just keep telling people to "buy and hold". Interestingly, guys like Edelman always fail to mention trend following's acceptance in the institutional community. Schools, governments, endowments and pensions are regularly investing with trend following traders. So while Edelman says, "don't do it", many people have some exposure to trend following already -- and for very good reasons -- it works.