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

Hedgelets: A Bet on Home Prices

May 31, 2005

HedgeStreet Inc., which lets investors trade a kind of derivatives online, is now letting participants "hedge" or speculate on the direction of home values in major U.S. real estate markets. The new Housing Price Hedgelets are tradable as both Yes/No and Variable contracts with three-month and six-month durations and are benchmarked against the National Association of Realtors reported median sales price of existing single-family homes in Chicago, Los Angeles, Miami, New York, San Diego and San Francisco. "For most Americans, their home is their single largest investment and, as such, the desire to reduce risks surrounding that asset is important," said John Nafeh, HedgeStreet's chief executive officer. "Housing Price Hedgelets provide a unique way for them to hedge against depreciation in the value of a home, or conversely, speculate on the degree to which housing prices will appreciate."

Altucher on Trend Following

May 30, 2005

James Altucher recently posted an article on trend following. The article has brought forward an abundance of feedback. One trend follower wrote me to say:

"JWH and the like advertise the riskiness of their investments on their sleeve, while some of the mean reversion hedge fund boys spend sleepless nights hoping no one ever figures out how much risk they are really taking. Who am I kidding? Most of those guys won't even admit to themselves how much risk they are taking!...there are many different frameworks that one may view the markets through in order to make trading decisions. All such frameworks are what they are, simply illusions that we create in order to help us take some action (yes, even trend following). The test of whether such a framework is useful in the long run is whether it supports us in doing profitable behaviors. If our framework helps us ride winners, cut losses, and manage risk then it is likely to lead us to profits. If the framework is not consistent with these things, then it is likely just part of a bigger game we play to meet some emotional needs and learn some important lessons with some help from the markets...Strategies like the ones Mr. Altucher mentions are not inherently bad. However, by nature they attract investors that have emotional needs that the strategies appeal to (low apparent volatility, feelings of offering value), and the investors are often eager to overlook many of the very real, but hidden, risks involved. It might take a superhuman manager to consistently manage such hard to see risks in the face of constant temptation to go for bigger returns. I don't like to set up situations where my financial well-being rides on someone consistently exhibiting superhuman skill and willpower. I would rather put my money in something that any idiot can manage as long as they don't try to get too cute and go around trying to avoid drawdowns."

My friend added more for those who think they can avoid volatility:

"If one focuses on the volatility of a trend trading strategy while understating its returns, and at the same time one ignores the "one time few-and-far-between huge drawdown events" typical of strategies that are built to avoid short term volatility of returns and one emphasizes the smoothness of the returns that exist outside that one time event, then one has an easily defeatable straw man trend follower to argue against. Reality shows us that strategies that have higher returns have higher risks. If you think you can get high returns without the commensurate level of risk, you might be prone to investing in strategies that do an excellent job of avoiding risk on 99.9% of days, but blow up on the other .1% of trading days."

Continue reading Altucher on Trend Following »

Book Rankings Update

May 29, 2005

Trend Following is currently ranked #1 in the "stocks" category at Amazon, #1 in "options" books and #2 in "futures" books. Thank you for the continued support.

Invisible Lead Steer

May 27, 2005

Michael Mauboussin of Legg Mason, back in his CSFB days, authored an interesting persepctive on the "lead steer". Read PDF report.

Richard Donchian

May 26, 2005

Donchian's Trading Guides

Richard Donchian documented his trading guides in 1934. He reviewed them in 1974, noting the ones he felt were the more important, some 40 years after they were first documented. The more important rules are reproduced:

General Rules:

1. Beware of acting immediately on widespread public opinion. Even if it is correct, it will usually delay the move.
2. From a period of dullness and inactivity, watch for and prepare to follow a move in the direction in which volume decreases.
3. Limit losses and ride profits, irrespective of all other rules.
4. Light commitments are advisable when a market position is not certain. Clearly defined moves are signalled frequently enough to make life interesting, and concentration on these moves to the virtual exclusion of others will prevent unprofitable whipsawing.
5. Seldom take a position in the direction of an immediately proceeding three-day move. Wait for a one-day reversal.
6. Judicious use of stop orders is a valuable aid to profitable trading. Stops may be used to protect profits, limit losses and take positions from certain formations such as triangular foci. Stop orders are apt to be more valuable and less treacherous if used in proper relation to the chart formation.
7. In a market where upswings are likely to equal or exceed downswings, a heavier position should be taken for the upswings for percentage reasons; a decline from 50 to 25 will net only 50% profit, whereas an advance from 25 to 50 will net 100%.
8. In taking a position, price orders are allowable. In closing a position, use 'market' orders.
9. Buy strong-acting, strong-background commodities and sell weak ones subject to all other rules.
10. Moves in which rails lead or participate strongly are usually worth following more than moves in which rails lag.
11. A study of the capitalization of a company, the degree of activity of an issue and whether the issue is a lethargic truck horse like Consolidated Edison or a spirited, volatile race horse like Case Threshing Machine is fully as important as a study of statistical reports.

Nicolas Darvas

May 25, 2005

Nicolas Darvas wrote How I Made 2,000,000 in the Stock Market years ago. There are many good lessons in it. A very relevant quote from Darvas' second book:

"My only sounds reason for buying a stock is that it is rising in price. If that is happening, no other reason is required. If that is not happening, no other reason is worth considering."

Sound like trend following?

In Time magazine in 1959 Darvas, the one-time dancer, was quoted as saying:

- "In my dancing I know how to judge an audience. It is instinctive. The same way with the stock market. You have to find out what the public wants and go along with it. You can't fight the tape, or the public."

- "I have no ego in the stock market. If I make a mistake I admit it immediately and get out fast...If you could play roulette with the assurance that whenever you bet $100 you could get out for $98 if you lost your bet, wouldn't you call that good odds?"

- "I never bought a stock at the low or sold one at the high in my life. I am satisfied to be along for most of the ride."

- "I am only in infant industries where earnings could double or treble. The biggest factor in stock prices is the lure of future earnings. The dream of the future is what excites people, not the reality."

James Montier

May 24, 2005

James Montier, an analyst with a behavioral finance edge, offers:

"Leaving the trees could have been our first mistake. Our minds are suited for solving problems related to our survival, rather than being optimised for investment decisions. We all make mistakes when we make decisions. Avoiding the most common investment mental pitfalls:

1 - You know less than you think you do.
2 - Be less certain in your views, aim for timid forecasts and bold choices.
3 - Listen to those who don't agree with you.
4 - You didn't know it all along, you just think you did.
5 - Don't take information at face value, think carefully about how it was presented to you.
6 - Vivid, easy to recall events are less likely than you think they are, subtle causes are underestimated."

Insight Welcomed

May 23, 2005

As mentioned the other day, I have spent the better part of the last 4 months interviewing 10+ great traders at their offices. This group manages collectively well over $10 billion USD.

I have met with both trend following traders and short-term systematic traders. The idea has been to assemble a representative sample of those traders excelling in the non-fundamentally based trading world. In a world still dominated by traders analyzing balance sheets and crops reports for their trading decisions, talking with great traders that make big money using statistically-driven trading models has been filled with "aha moments".

As the research process continues, I would like to now use the power of the web to find other interview candidates across the globe. If you currently trade trend following models or if you currently trade short-term systematic models, I would like to discuss a conversation for a future book. Feel free to contact me here. You do not have to be a trading manager to participate, you could simply be trading your own account. All communication on this issue will be considered private until all parameters are agreed upon.

2think.org Insights

Sometimes 2think.org is the perfect tonic. Consider some of my favorites:

"When you make the finding yourself--even if you're the last person on Earth to see the light--you never forget it."
Carl Sagan

"If you try to impose a rigid discipline while teaching a child or a chimp you are working against the boundless curiosity and need for relaxed play that make learning possible in the first place... learning cannot be controlled; it is out of control by design. Learning emerges spontaneously, it proceeds in an individualistic and unpredictable way, and it achieves its goal in its own good time. Once triggered, learning will not stop--unless it is hijacked by conditioning."
Roger Fouts

"A man's ethical behavior should be based effectually on sympathy, education, and social ties; no religious basis is necessary. Man would indeed be in a poor way if he had to be restrained by fear of punishment and hope of reward after death."
Albert Einstein

"The biggest cause of trouble in the world today is that the stupid people are so sure about things and the intelligent folks are so full of doubts."
Bertrand Russell

"Fear is the main source of superstition, and one of the main sources of cruelty. To conquer fear is the beginning of wisdom."
Bertrand Russell

Big Picture Reminder

May 22, 2005

From a Graham Capital presentation, this chart is a simple reminder of the trend following typical "winner":

Flocks and Hordes

Where do trends come from?

"No matter what the models say, traders are not machines guided by silicon chips; they are impressionable and imitative; they run in flocks and retreat in hordes."
Roger Lowenstein
When Genius Failed: The Rise and Fall of Long-Term Capital Management

Emotional Intelligence

May 20, 2005

Succeeding with Emotional Intelligence.

Beating Rogers for the Moment

May 19, 2005

It's not easy to be ahead of Jim Rogers when it comes to selling books, but for the moment Trend Following (#219) is ranked ahead of Jim Rogers' Hot Commodities (#234) on Amazon in their sales ranking of all books.

Japanese Newspaper Column

A column in a Japanese daily newspaper that I am writing.

Additionally, the translated Japanese version of Trend Following is now available.

Bloomberg Radio Interview

May 18, 2005

A recent interview with Bloomberg Radio (6.5 MB MP3 audio file) and Mike Covel about trend following.

Too Simple; Not Wise

Here is a sample of some stock market marketing aimed at kids. Dollar cost averaging, as pointed out in Trend Following, is also known as losers average losers.

Rankings Across Categories

May 17, 2005

Amazon book ranks for Trend Following across categories today:

#510 > All Books
#77 > All Books > Business & Investing
#12 > All Books > Business & Investing > Investing
#2 > All Books > Business & Investing > Investing > Stocks
#2 > All Books > Business & Investing > Investing > Futures
#1 > All Books > Business & Investing > Investing > Options

Technical Analysis Magazine Cover

June 2005 Cover

Amazon Book Rank for May 2005

May 16, 2005

Nearly 13 months after release Trend Following continues to reach a wide audience. Amazon sells millions of different books and today Trend Following was ranked #764 of all books available. Thanks for the continued support. As always your feedback and comments, both positive and negative, are welcomed.

Miami Area Trend Follower

I interviewed a Miami area trend follower in his office this past Friday. While a younger man in terms of age, he has a track record exceeding 20% per year dating back to the early 1990s. He manages nearly $500M USD for clients.

In a surprising way, he quickly jumped into the philosophical elements of trend trading. All he could do was shake his head when I mentioned that some people still feel his kind of trading is bogus. "Do they not add up the profits" was his paraphrased response back.

He did drive home a crucial point about diversification from his perspective. Essentially he said, "what is the point of diversification if you can simply ride the big trenders each year while excluding the losers from your portfolio?" Of course this really would be the Holy Grail of trading, but perhaps as this trader hinted "some" are headed there as we speak.

Interview with Technical Analysis Magazine

May 15, 2005

My front cover interview with Technical Analysis of Stocks & Commodities Magazine is currently out in the June 2005 issue: read the interview now.

Seven Stages of a Bear Market

May 14, 2005

Woody Dorsey in his book "Behavioral Trading" speaks to what he calls the Seven Stages of a Bear Market:

1. Mania - Peak of Dot-com Bubble, December 1999.
2. Denial - After falling sharply, the market rallied in summer-fall 2000.
3. Hope - Though the market fell again, it rallied back in summer 2002.
4. Recognition - The market plunged after the 9/11 terrorist attacks in New York.
5. Reprieve - The market rallies steeply (forecast).
6. Liquidation - The market sells off and slides definitively (forecast).
7. Capitulation - The market bottoms (forecast).

In an after the fact analysis, these points hit home and provide great food for thought. Just remember though, to trade in the present will require a strategy that answers the following 5 questions:

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

Good Advice

May 12, 2005

I caught a brief story today about 'exits'. The following excerpt is right from the trend following play book:

"It's a common enough saying that people use in various situations in everyday life. But when you're a stock investor, the phrase "cut your losses" takes on a special meaning. Investors are tempted to hang onto a stock that's begun to tank. It's easy to think, "Well, this stock can't go any lower," or "It's a good company; the stock will come back." But you don't get ahead in the market by hoping and wishing and guessing. A better plan is to apply a strong set of rules that have worked. While your stock-buying rules are your offense, your sell rules are your defense. It's inevitable that you'll make mistakes or you'll buy a stock at exactly the right point, but the breakout fizzles. You want a Plan B ready for those situations. Here's what that Plan B looks like: Say you bought a stock at the proper entry point. But the breakout goes awry, and the stock moves lower. Keep an eye on it. If it falls 7% to 8% below your buy point, sell it."
Investor's Business Daily
Katharine Stalter

Amazon Book Pricing Back to $20

May 11, 2005

The publishing business is a mine field. My book Trend Following has finally had its price reduced back to a normal roughly $20 a book at Amazon. Unfortunately, over the last 10 weeks my publisher and Amazon had disputed "pricing" which resulted in a temporary raise of my book price on Amazon to nearly $30 a book.

If anyone ever desires insights on publishing a book today, drop me a line.

European Trend Trader

Conducting interviews over the last 5 months has revealed "niches" among trend traders. What do I mean? My book Trend Following covers a distinct grouping of price-based trend following traders. There are, however, traders who trade trends using different entry and exit methods. Instead of relying on price, some rely on specific mathematically based patterns for their entries and exits.

Today I had a conference call with one such trader. Based he Europe, he manages over $1 billion USD in client money and has a track record exceeding 10 years (this is a different trader than the one I met with last Friday in New York City). The big picture lesson? Even if most trend traders are highly correlated, if you work hard and do the research, there exist uncharted territories in trend trading yet to be conquered.

But does this mean this trader's philosophy is entirely different than trend followers? No, not at all. It means he has found a space where he thinks his method of entry and exit are superior. He still, like trend followers, must use great risk management to control his downside. And at the end of the day, he too needs trending markets to make money.

Aggressive Trend Follower

May 10, 2005

I interviewed a very successful trend follower last Friday in his New York City office. This man to some may seem young (he is in his mid-thirties), but his firm has been producing great returns for nearly 10 years. He got his start in Europe appealing primarily to non-US investors, but now reaches thousands of clients across the globe. Today he manages well north of $1 billion USD in client capital.

No one would have left this meeting without a deep appreciation for this man's aggressive nature. He doesn't wait for people to give him permission. He is 100% entrepreneur through and through aiming to make "it" happen. Some think the key to success is some secret formula, but the real key is to just get started. Just do it.

Skill v. Opportunity (& Luck)

May 09, 2005

Can a great trader have great skill and no opportunity to make money? Can a bad trader have no skill and tons of opportunity to make money? The answer is yes to both questions. Luck is at play in the short-term for most traders. There will always be "some guy" with a great one year return. The sustained edge appears only over time.

What's the point? What happens when the bad trader with no skill finally finds himself with no opportunity? Think about it.

Jon Sundt of Altegris is to be thanked for the root of this analogy. He made it at a recent symposium I attended.

Hangover

May 08, 2005

Is there something new in general market activity? Has something changed? The New York Times offered a perspective rooted still in the dot com explosion of 5 years ago. Of course this information does not figure into a trend following model, but as after the fact analysis, it is food for thought.

Continue reading Hangover »

From A New Fund Manager

May 07, 2005

Feedback from a reader:

"Michael, I just picked up the new SFO dedicated to trend following. Your article was with out a doubt one of the best articles to appear in SFO in a long, long time...[also] thank you for writing the book [Trend Following]. Since my beginnings in the commodity industry as a retail broker 4 years ago I could never put the words down to explain the way I view the markets. Reading your book solidified my feelings and has been one of the motivating factors in my decision to start a [fund]...I have lost count of how many times I have lent out my copy or recommended it to people who want to make a living in the market. After 4 years it still amazes me how many people discount the idea that price is the only thing that matters."
Bobby F.

Confusion and Critics

May 06, 2005

It seems "some" believe I don't accentuate drawdowns of trend followers enough. I am very clear on pages 95-100 of my book Trend Following. Trading is risky. You can win and you can lose...and drawdowns are part of the game.

The issue of "testing" by trend followers was also recently broached as a trend following critic declared:

"[Trend following systems] are often untested...If tested, their variability is too high to rule out randomness, and...If tested relative to uncertainty, they assume past seemingly non-random movements of prices are predictive of what's going to happen in the future."

I find these comments odd. Does this critic really believe trend follower David Harding, as one example, does no testing of his trend following methods? Does this critic believe 25 plus years of performance from various trend followers is actually random luck?

Currency - An Asset Class

May 05, 2005

Currency - An Asset Class (PDF Whitepaper).

Representing Uncertainty

May 04, 2005

In doing some research on the concept of 'uncertainty', this paragraph caught my eye:

"If there is one thing that defines and limits our efforts to better understand extreme and rare events it is uncertainty. Uncertainty arises from both an imperfect understanding of the rare events and processes we wish to study (e.g., terrorism, natural hazards), and the imperfect, out-of-date, and incomplete data we must work with in order to try and understand these events and processes."
Mark Harrower
University of Wisconsin-Madison

Along these lines consider the following white paper "Confronting Uncertainty: Intelligent Risk Management with Futures" from trader Robert M. Tamiso: View PDF.

Darwins Mind

May 03, 2005

A interesting read titled, "Darwins Mind: The Evolutionary Foundations of Heuristics and Biases."

Balancing Out

When you trade as a trend follower, losses are often paid for with gains. Meaning there will be periods of up and down volatility with no clear trend directions. When the trends "hit" (something you can't predict), then the gains far out pace losses. Sunrise Capital offered the following commentary for March 2005:

"The Global Monetary Program declined 4.8% in March, as investor sentiment suddenly turned bullish regarding the U.S. dollar, resulting in sharp reversals in most currency markets and, to a lesser extent, metals. The ensuing losses from long positions in the euro, Swiss franc, Australian dollar and Japanese yen easily outpaced gains from long positions in Japanese government bonds and short positions in Eurodollars. The stock index and energy sectors posted modest losses as well...Long positions in crude oil had benefited early on from a perceived increase in global demand and a tightening of supply. On the 23rd, however, U.S. government data showed that crude inventories were, in fact, growing, and the market reversed sharply. Gains from long positions in metals also saw a turnabout led by gold, which reversed to the downside as the dollar gained strength after midmonth."
Sunrise Capital

Of course their fundamental analysis is after the fact and plays no role in their real-time decision making process within their trend following model.

Social Security Fraud

May 02, 2005

From the President the other day:

"It's the biggest tax [social security] a lot of people pay...And younger Americans are saying, 'I'm not so sure I'm going to see it.'...Some youngster told me about the survey that said many young people are -- think it's more likely they're going to see a UFO than get a Social Security check."

If you are below 40 -- give or take -- you better figure a way to make some money in the markets independent of any Federal program. You will not be getting a check of substance (unless taxes are raised) from the government when you retire, so come to grips with that fact now and do something about it.

Bush continued:

"Don't you like the idea of people paying attention to their assets and watching them grow?...I think it's an incredibly fantastic opportunity to spread that opportunity throughout our entire society."

Trying to logically teach this to a population, 50% of which lives on Fantasy Island, is a hard sell.

Recent feedback to my post?

"With your social security entry in your blog, you stepped into a messy situation. Social security will be there for decades. That is a fact. Only Congress can change that and that is not likely. Bush's solution to social security is buy-and-hope. Workers are forced to put their money into a fund. Probably an index fund or a bond fund. Then they have to hope the market is good to them for some arbitrary number of years. If not, they lose. I don't see how you could endorse something like Bush's solution."
Reader

My response?

I am endorsing no plan. This is an issue of math. Compounding government bond interest? The math will take you nowhere. If you want a no interest investment put together by politicians who have no clue how to make money -- be my guest! Otherwise -- let's all be honest and admit it is just a tax and not a viable solution for retirement years.

Fibonacci Hype

May 01, 2005

People sometimes wonder where do market losers come from. One source of market losers comes from those that believe this type of talk:

"The Fibonacci series is a number progression in which each successive number is the sum of the two immediately preceding it: 1, 2, 3, 5, 8, 13, 21, 34, 55, and so on. As the series progresses, the ratio of a number in the series divided by the immediately preceding number approaches 1.618, a number that is attributed significance by many traders because of it appearance in natural phenomena (the progression a shell's spiral, for example), as well as in art and architecture (including the dimensions of the Parthenon and the Great Pyramid). The inverse, .618 (.62), has a similar significance. Some traders use fairly complex variations of Fibonacci number to generate price forecasts, but a basic approach is to use ratios derived from the series to calculate likely price targets. For example, if a stock broke out of a trading range and rallied from 25 to 55, potential retracement levels could be calculated by multiplying the distance of the move (30 points) by Fibonacci ratios -- say, .382, .50 and .618 -- and then subtracting the results from the high of the price move. In this case, retracement levels of 43.60 [55 - (30*.38)], 40 [55 - (30*.50)] and 36.40 [55 - (30*.62)] would result. Similarly, after a trading range breakout and an up move of 10 points, a Fibonacci follower might project the size of the next leg up in terms of a Fibonacci ratio -- e.g., 1.382 times the first move, or 13.82 points in this case. The most commonly used ratios are .382, .50, .618, .786, 1.00, 1.382, and 1.618. Depending on circumstances, other ratios, such as .236 and 2.618, are used."
April 2005 Currency Trader

Peter Panholzer on Risk

Peter Panholzer, a short term systematic trader, recently offered:

"We don't always understand that risk isn't always a money risk; there's the risk of regret. Sometimes you regret you haven't been in the market, sometimes that you got out too early or that you've taken a loss when it wasn't necessary. It's not only the money we worry about, it's also our regret we worry about."
Peter Panholzer

He continued:

"System trading is different from technical trading...In technical trading, you're reading tea leaves - the indicators. Interpretation of technical indicators is often subjective and not programmable. But you can program a system."
Peter Panholzer