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

Technical Trading

April 29, 2005

Food for thought:

"Technical trading is not glamorous. It will rarely tell that you bought at the lows and sold at the highs. But trading should be a business, and a systematic program is a plan to profit over time, rather then from a single trade. High expectations are essential to success, but unrealistic ones just waste time. Computers do not tell the user how to make profits in the market; they can only verify our own ideas. We consider using a computer to develop trading programs to be a sensible, conservative approach."
Cognitrend GMBH

Angry, Angry Reader

April 28, 2005

This email arrived just about one year ago today from someone named "Joe Blow":

"What do you know about trading?...You have written regurgitated fluff on the facts that long terms exist. Bravo. Your book reminds me of how Kiyosaki writes on money to the masses - totally useless. I would not read anything you have to say and I am sure to see your book at a discount in Borders selling $4 - like so many."

As Ed Seykota might say, perhaps it is time this reader look into himself and analyze the root of his anger. In terms of the price of my book, I would like to see Amazon drop the price some, but it doesn't appear $4 a book will be here any time soon!

Lost Broker Feedback

April 27, 2005

I just received an email obviously not meant for me. A Senior Vice President in Futures and a Senior Metals Specialist from XXX (very large investment bank) emailed me thinking I was someone else:

"I have clients with XXX Fund (which you manage at XXX), and wonder if you could either give me a call or email me with a comment about the...weakness of the fund. I'd also like to know if you might be planning to implement any changes in risk management strategy to cope with a market that is currently non-friendly to trend-following systems, as well as any thoughts you might have as to when market conditions might turn more favorable towards systematic traders such as XXX. I would really appreciate it if you could address each of these questions."

Why would an individual who has placed client money with a trend following trader be asking these questions? The clients of this broker are being poorly served to say the least.

May 2005 Issue of SFO

April 26, 2005

The May 2005 issue of SFO Magazine is dedicated to trend following.

I have an article in this issue titled "The Reports Of My Death Have Been Greatly Exaggerated".

Hedgestreet Trading

Good overview of Hedgestreet service and concept.

Sharpe Ratio Thoughts

April 25, 2005

How should one look at trend following performance? Winton Capital, David Harding's successful trend following shop, offers insights from their recent white paper PDF.

The Long Range Vision

April 24, 2005

I attended a recent conference that exposed investors to various hedge fund opportunities. Many of the opportunities were of the trend following variety or were well known opportunities from legendary global macro traders.

There were, however, several what I call "visionaries".

These were very bright men, understanding of history and loaded with visions of where our future will be in 10, 20, and 30 years. But at the end of the day should you make a "bet" on the fundamental vision of one man looking out 20 years or should you make a "bet" on traders that have specific risk management philosophies, entry & exit approaches and portfolio selections that deal with the here and now?

It is an interesting choice.

SEC Hedge Fund Roundtable

April 22, 2005

Hedge fund roundtable put on by SEC. Just another perspective.

Not Dumping the Losers

April 21, 2005

"...an example of laziness is not dumping the losers. I recall that when I was a young sprig, I read about the Dow Theory of investing or maybe a commentary about it. The simple rules included the admonition to cut losses and let your gains run. I used to do that scrupulously, but as old age and superstition have overtaken me I often leave losers and carcasses on my statements. Maybe part of the reason is the few minutes of work it would take to learn the cost basis and then the shattering realization of how huge my capital losses were. (Yes, I was suckered into buying Internet stocks, too. Luckily, in fairly small numbers, or I would be writing this from a padded cell.) When a stock has been a loser for a long time, say sayonara, in the words of Marlon Brando, even if it takes a bit of work to do it."
Ben Stein
New York Times

Fraud Is Not Enough

April 20, 2005

Is fraud enough to claim you suffered damages? Consider:

"A unanimous U.S. Supreme Court refused on Tuesday to make it easier for disgruntled investors to sue companies and seek damages in certain securities fraud cases...The high court overturned a ruling that companies can be sued for misleading statements that inflate their stock, even if the stock's subsequent decline is not directly tied to the company's later "corrective" disclosure of the fraudulent misrepresentation..."A private plaintiff who claims securities fraud must prove that the defendant's fraud caused an economic loss," Justice Stephen Breyer said in the court's opinion...Dura investors said they should recover for losses from a precipitous stock drop, arguing that the company knowingly made false statements about the device's prospects..."We consider a Ninth Circuit holding that a plaintiff can satisfy this requirement simply by alleging in the complaint and subsequently establishing that the price of the security on the date of purchase was inflated," Breyer wrote. "In our view, the Ninth Circuit is wrong."
AP Wire

It seems to me the Supreme Court is essentially saying that even though Enron, for example, might have been a sham, you still bear responsibility if you did not exit as the share price dropped from $90 to pennies.

A Chart

This sure is a chart worth staring at. What a story it is. Fortunes made and fortunes lost.

March Comment from Old Pro

April 19, 2005

Read March 2005 commentary from old pro trend follower.

Critical Insanity

April 18, 2005

There are critics of trend following out there. But their typical method of operation is to launch personal attacks instead of debating the strategy on the merits. That said, in today's Washington Post Howard Kurtz wrote an article titled "For Every Story, An Online Epilogue Via E-Mail and Blog, Anyone's a Critic". Some excerpts of where the anonymous chat/blog world has gone:

"ABC's Linda Douglass says she has "learned that I have not just critics but people who seem to hate me that I don't even know about." "It's very nasty and personal and scatological," says Washington Post reporter Dana Milbank." But the increasingly caustic nature of some online criticism is prompting many journalists to complain that their honesty and motivation are being trashed along with their work."
Howard Kurtz

"You want to pay attention to what legitimate critics are saying out there," Nagourney says. "In journalism, you screw up from time to time. But it's become so toxic -- attacks for the sake of attacks." "As for "smear artists" on the Internet, Greenfield says, "The freedom that it gives anonymous twerps to spew out invective -- that they don't like the way you look or think you're an idiot or a child abuser -- that's just part of the process."
Howard Kurtz

"There's so much noise that you have to tune it out. It's very rare I'll write any story that doesn't get criticized by someone...Complete strangers make assumptions that they know your innermost thoughts."
Howard Kurtz

Tom Friedman's New Book

In Tom Friedman's book The World is Flat he argues:

"It was like they were all 'pod people', living in a parallel universe, who were in on a big secret. Yes, they all knew the secret, but nobody wanted to tell the kids...everyone is going to have to improve themselves and be able to compete. It is just going to be one global market. Don't be fooled by the calm. That's always the time to change course not when you're just about to get hit by the typhoon. The way to avoid being caught in such a storm is to identify the confluence of factors and to change course even though right now the sky is blue, the winds are gentle, and the water seems calm...After all look how clam and sunny it is outside."
Tom Friedman

Friedman, while he did not plan it, lays out the case against buy and hold (hope). The Nasdaq is still down -60% after 5 years. Had enough yet?

Legg Mason's Mauboussin

April 17, 2005

Two good PDFs from Michael Mauboussin of Legg Mason.

New England Trend Trader

I met with another great trend follower last week in his office. He has been trading as a trend follower since the early 1980's. Based in the New England area, he currently trades $1 billion in his fund. The big picture lesson? Humility. This man knows there are ups and downs. He understands there is volatility. Unlike some trend followers, he trades with less risk shooting for less of a return. With all of his success though, he is humble. He keeps grounded. I am sure there are up and coming traders full of ego, but this man is not one of them. He knows the market can take away what it gives and he is always worried about managing the downside. More to follow in the coming months...

Desire to Get Trend Following

April 16, 2005

Two weeks ago I met with a near billion-dollar hedge fund in their Texas office. Funded primarily from the principals' personal wealth (they hit it big with one of the top technology firms of all-time), their firm was seeking insights into trend following. They want to invest with trend following traders, but they are having a hard time wrapping their arms around a strategy (trend following) not rooted in fundamentals.

The three executives I met with at this hedge fund were more comfortable with a trader who traded one market alone. They liked the idea that a trader might be able to fundamentally know everything he could about that one market. They liked the idea of that type of skill compared to trend following skill. The trend following skill of reducing all markets to the common denominator of price just did not connect with them.

My gut says they will eventually put money with trend following traders. This group is very bright and they are doing extreme due diligence on trend following trading. Unlike some who dismiss trend following, these folks will get it since they are willing to learn something new.

Say What Yahoo?

April 15, 2005

View this screenshot from Yahoo Finance yesterday. From the headline, to the story copy, to the content of the advertisement, how does any of this help you to know when to buy or sell a market?

Take Charge; No Whining

April 13, 2005

A reader writes in today:

I like the "inspirational trader talk"...I read Michael Covel's book Trend Following...and I'm finding myself as frustrated with the website as the book made me. It seems like one long advertisement for the "star money managers". I want to be a "Trend Follower" myself. I study price charts and am looking for true insights into mechanical trend following."
Reader

Trend following starts with an idea. It starts with a philosophy. It starts with curiosity. It starts with the passion to make it happen -- above all else. It doesn't start with some magic indicator. It doesn't start with some Holy Grail or some "wondrous line of computer code". It doesn't start with whining!

The book Trend Following uses examples of the thought process, philosophy and technique of great trend following traders. The book has reached tens of thousands of readers. The feedback has been overwhelmingly positive. For that I am grateful. But what about those that miss the wisdom of the great traders? Wisdom anyone can take and apply?

There is a lesson to be learned from the words of the reader above. For some people even if there were some "magic", if they had it, they would still cry they didn't have it. I bet the above reader will search his whole life and will never find "it"...when "it" will be right in front of him the whole time.

Hedge Fund Event

April 12, 2005

I attended a hedge fund event put on by a top MBA program recently. The event had no trend following traders, but did have several fundamentally based hedge funds as speakers.

One man who spoke was obviously a very bright guy. An economist by training, he currently runs a long/short hedge fund. He spoke for over an hour working through chart after chart of various economic indicators. I felt like I was back in my MBA program!

He mapped out a scenario that left me feeling like that 10 years from now the Nasdaq chart could look like the Nikkei has looked like for the last 15 years. He laid out the case for interest rates, housing bubbles, consumer demand, over-capacity, etc. Given his grasp of the subjects, he will probably be on target with his various economic projections.

When he finished he left me with the strong feeling that his economic view might be right, but his trading plan (whatever it might be exactly), might lag. Meaning markets often move contrary to the fundamentals. They overshoot. They go down when the fundamentals are positive. They go up when the fundamentals are negative. How was this extremely bright guy connecting his strong economic view to the basics of when to buy and when to sell? What was his entry and exit plan? His money management plan?

I left his presentation with blanks.

What Are the Odds?

April 11, 2005

Consider:

"The true meaning of the word [odds] is ''a surprising concurrence of events, perceived as meaningfully related, with no apparent causal connection.'' In other words, pure happenstance. Yet by merely noticing a coincidence, we elevate it to something that transcends its definition as pure chance. We are discomforted by the idea of a random universe. Like Mel Gibson's character Graham Hess in M. Night Shyamalan's new movie ''Signs,'' we want to feel that our lives are governed by a grand plan. The need is especially strong in an age when paranoia runs rampant. ''Coincidence feels like a loss of control perhaps,'' says John Allen Paulos, a professor of mathematics at Temple University and the author of ''Innumeracy,'' the improbable best seller about how Americans don't understand numbers. Finding a reason or a pattern where none actually exists ''makes it less frightening,'' he says, because events get placed in the realm of the logical. ''Believing in fate, or even conspiracy, can sometimes be more comforting than facing the fact that sometimes things just happen.''...We are far too taken...with superfluous facts and findings that have no bearing on the statistics of coincidence. After our initial surprise...the real yardstick for measuring probability is ''How surprised should we be?'' How surprising is it, to use this example, that two 70-year-old men in the same town should die within two hours of each other? Certainly not common, but not unimaginable. But the fact that they were brothers would seem to make the odds more astronomical. This, however, is a superfluous fact. What is significant in their case is that two older men were riding bicycles along a busy highway in a snowstorm, which greatly increases the probability that they would be hit by trucks...Statisticians ...emphasize that when something striking happens, it only incidentally happens to us. When the numbers are large enough, and the distracting details are removed, the chance of anything is fairly high. Imagine a meadow, he says, and then imagine placing your finger on a blade of grass. The chance of choosing exactly that blade of grass would be one in a million or even higher, but because it is a certainty that you will choose a blade of grass, the odds of one particular one being chosen are no more or less than the one to either side...One relatively simple example of this is ''the birthday problem.'' There are as many as 366 days in a year (accounting for leap years), and so you would have to assemble 367 people in a room to absolutely guarantee that two of them have the same birthday. But how many people would you need in that room to guarantee a 50 percent chance of at least one birthday match? Intuitively, you assume that the answer should be a relatively large number. And in fact, most people's first guess is 183, half of 366. But the actual answer is 23. In Paulos's book, he explains the math this way: ''[T]he number of ways in which five dates can be chosen (allowing for repetitions) is (365 x 365 x 365 x 365 x 365). Of all these 3655 ways, however, only (365 x 364 x 363 x 362 x 361) are such that no two of the dates are the same; any of the 365 days can be chosen first, any of the remaining 364 can be chosen second and so on. Thus, by dividing this latter product (365 x 364 x 363 x 362 x 361) by 3655, we get the probability that five persons chosen at random will have no birthday in common. Now, if we subtract this probability from 1 (or from 100 percent if we're dealing with percentages), we get the complementary probability that at least two of the five people do have a birthday in common. A similar calculation using 23 rather than 5 yields 1/2, or 50 percent, as the probability that at least 2 of 23 people will have a common birthday.'' Got that?"
The Odds of That, New York Times
Lisa Belkin

The great traders "get" all this. Do you?

Oil Contrarian Sees Bubble Bursting

Even if the guy below is right...how would you know when to buy or sell:

"Most energy analysts on Wall Street expect oil prices to remain high for the foreseeable future because of strong demand and limited supply. Then there is Tim Evans, a contrarian who says today's crude oil prices above $50 a barrel reflect nothing more than a market bubble fed by speculation and unwarranted fear. Evans, a senior analyst at IFR Energy Services in New York, believes oil prices could plummet to $28 a barrel as early as this summer. "I guess that makes me the lunatic fringe," Evans said, followed up by a burst of laughter. Evans' basic message is that the world's oil supply is sufficient to meet demand, that motorists will soon show that they're not willing to pay any price for gasoline and that the market is unreasonably receptive to worst-case-scenario thinking...Evans scoffed at the Goldman Sachs report, saying "the probability of reaching that price level is so small it's, like, laughable." "Yes, $105 could happen. Texas could slide into the Gulf of Mexico. There could be a nuclear war with Iran. But you know that in a scenario like that I somehow don't think the world economy is going to be screaming for more oil." Evans is not the only contrarian -- there are still a handful of analysts forecasting prices below $40 a barrel in the second half of the year -- but he may be the most blunt voice of opposition to the bullish market consensus. He sums up the group-think this way: "Greed makes you stupid." When asked why the market would ignore what he considers to be an adequate supply situation and instead focus on everything that could wrong to disrupt it, Evans answered with a question. "Why did people chase Internet stocks in the late 1990s, and why did they shift from looking at earnings to looking at revenues and from looking at revenues to looking at the number of hits on a Web site as a method of valuation?"
Oil Contrarian Sees Bubble Ready to Burst
Associated Press
Monday April 4, 5:48 pm ET
By Brad Foss, AP Business Writer

Probability of Life

April 10, 2005

"To make a simple point, it would be impossible to take a profit (or loss for that matter) unless price trended at least a little bit. Can one know absolutely when price will trend? No....Does one have to know absolutely in order to have a profitable business? Certainly not. In fact, a great number of businesses are based on the probability that a time based series will trend. In fact, if you look at insurance, gambling, and other related businesses, you will come to the conclusion that even a small positive edge can mean great profits."
Chat Forum Post

Working from Home

April 09, 2005

I had the opportunity to visit with one of the best trend followers today. Living in the Chicago area, he works from his home office with a small staff. He might not be the largest trader (he does trade many hundreds of millions), but his performance is top notch. He is also just a fun and interesting person. No quant jock stiff here.

This trader, unlike some trend followers, has plenty of fundamental opinions. He reads voraciously on the markets and is not afraid to wear his emotions or concerns on his sleeve. This is precisely why he relies on a trading model.

He knows he can be volatile. He knows he can be emotional. And he is bright enough to never let those personal views interrupt his trading system. In his world, his well thought out automated trading strategy keeps it all in check.

Elliott Wave Hype

April 07, 2005

Does this seem valid? Or is it entirely subjective?

"All three major U.S. stock-market indexes ended their respective early millennium bear markets by way of triple bottoms with lows in July 2002, a lower low in October and a higher low in March 2003. Since then, they've all been following a certain upward-trending slope. For the Nasdaq Composite, you can go back to the Oct. 10, 2002, bear-market low of 1,108 and draw a line connecting the lows of March 12, 2003 (1,253), Aug. 13, 2004 (1,750), and March 29, 2005 (1,968). And now Monday's low of 1,972. This is a classic complete uptrend with a clear five waves: the bulls' initial test rally (two-month surge to December 2002 high of 1,521); the denial by bears (two-month dip to March 2003 low); the acknowledgement of the new trend by both parties (the longest and most powerful stage, with a 10-month rally to January 2004 high of 2,153); a brief rest and consolidation period (seven-month decline to August 2004 low of 1,750); and then the final exhaustion rally (five-month run to January 2005 high of 2,191). In this Elliott Wave Theory scenario, the current decline indicates the uptrend should now undergo a three-wave correction. And that is why there might be a bounce; the recent decline could be the first wave of a decline. But given what the Nasdaq has done recently, it won't be because new buyers are entering the market or old buyers are adding to positions, but because the trend line would provide a convenient reason for sellers to book some profit by partially closing positions."
Marketwatch

Beliefs Are Key

Whether you think you can or you can't, you're right. This might sound simple, but is it not what separates greatness from average?

Why Trend?

April 06, 2005

Why do markets trend:

"Whether it's because of gradual dispersions of data, participants' interpretation of data, fundamental factors or seasonal factors, historically, markets trend," says Bruno. "You can get the edge if you approach them with a systematic, disciplined trend-following methodology and, over time, extract consistent profits from them in either direction."
Thomas Bruno

But once you believe in "trends", adopting the trading philosophy is next:

"When the firm's computer programs identify that a trend has begun, Campbell's traders will "join that trend and, at the same time, determine a point where we will exit if we are incorrect," says Little. If the trend continues, these traders will follow with a trailing stop. Little adds that they do not automatically reverse, and will often have no positions in trendless markets."
Managed Account Reports

Trendlines Playing Tricks

Technical analysis is often abused. Many people think it is all about prediction. Some think trendlines offer use. A common thought from those that believe in predictive trendlines:

"Trendlines work quite well and are not uncommon."

We came across a good refutation of trendlines:

"Tendlines exist only in the eye of the beholder. Where you draw a trendline will be different to where someone else may draw a trendline. To use them for generating entry signals is about as useful as random entry. Visual containment is about their only use. but if you cant tell the direction from simply looking at a chart then you have problems...The problem for me though [with trendlines]...is my broker won't let me trade in the past. He insists I make all decisions on the hard right hand edge of the chart."

The Downside

April 05, 2005

How do you view your trading downside?

"Most traders, being trend followers, get hurt whenever a [market] reverses course. But downside is managed using several techniques: quick stop loses, maintenance of the bulk of assets in treasury bills, and adjusting leverage in opposition to prevalent market volatility. Jeremy O'Friel...emphasises the importance of constantly manipulating "gearing" (another term for leverage) as a means of maintaining a consistent level of risk as the economic environment changes."

Offshore

Whether one has a need or not for offshore fund management, this link from Ernst and Young will lead to interesting insights.

But I thought...

April 04, 2005

From Reuters:

"At 10:33 p.m. EDT Sunday, U.S. crude was up 31 cents at $57.58, while London's Brent crude struck an all-time peak at $56.80 a barrel, marking a gain of 29 cents. "I would have thought prices would struggle to go much higher. The market fundamentals suggest lower prices," said Mark Pervan, an analyst with Daiwa Securities in Melbourne. "I think they will struggle to get over $60 in the next couple of weeks -- that is a big psychological barrier."

Isn't this always the case? An incorrect fundamental view is rationalized away after the "bad call". It is also a great example of the disconnect between fundamentals and price.

CTA Guide

First, as a quick reminder regarding Wall Street jargon, read this.

Now read this comprehensive PDF (424 kb) from the Chicago Mercantile Exchange. This document will be useful whether you trade for yourself alone or whether you are seeking to trade for clients.

Nonrandom Moves

April 03, 2005

Sunrise Capital gives trend following an explanation:

"The objective is not to attempt to buy lows and sell highs, but rather to buy market strength and sell market weakness. The underlying theory is that markets periodically exhibit nonrandom price movements or trends that are persistent and can be exploited by an approach that does not forecast, but simply follows price trends. Trend-following models apply quantitative analysis and/or pattern recognition algorithms to the daily price data of the market being traded, which serves as the sole data input to the model. This approach, commonly referred to as technical analysis, is based on the concept that all fundamental or external data that might impact a specific market is already reflected in the current price."
Sunrise Capital

The Short Debate

April 02, 2005

The Wall Street Journal ran a story the other day titled "List of Challenges for Short Sellers Keeps Growing Longer." The piece questioned whether short trading was still viable, but also made the case as to why short selling is a needed part of our market system.

One guy in the article opined, "For me, shorting has changed from being an inherent strategy to a more tactical strategy."

Trend following trading on the other hand has always been tactical or said another way opportunistic. Trend followers don't wake up and aim to be all "long" or all "short". Trend followers can be either long or short depending on which way the trend is going.

The Wall Street Journal article unfortunately continues the idea that you are either long only all the time or short only all the time. Why write this when the best traders don't think or trade with such belief sets?

Crude Higher; Confusion Persists

A few weeks back I was in a noted trend follower's office. They just happened to be buying crude oil that day -- at around $55. This trader remarked how tough it is to take the trades at "highs". From any historical perspective $55 is near the all-time high, but as this trader pointed out he had no idea how much higher it could go so the best he could do was follow his trading system and go long crude oil at $55.

Today I received an email from a reader asking, "how far into a trend do I still enter? Is there a practical limit of when to not enter anymore? Do I still enter or is it already too late? Are there some rules here?"

The contrast between these two men is clear.

Bull v. Bear

April 01, 2005

I just flipped on CNBC and randomly caught a debate titled "bull v. bear" between Brian Belski of Piper Jaffray (as the bull) and Michael Metz of Oppenheimer (as the bear). They both argued for 10 minutes about whether the stock market was bullish or bearish.

Thoughts on this exchange:

1. Neither of them know the answer.
2. Do the people that run CNBC really believe this kind of debate serves a purpose or is it just some Crossfire-like info-tainment?