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

Your Gain is Another's Loss

August 30, 2005

In a recent USATODAY.com a reader asked, "When a person loses money in the stock market, does that always mean another person is winning? Is the stock market simply like a casino where one man's lost is another man's gain?"

"Professional investors never like the stock market to be described as a gambling hall. After all, investors never like to think of their investment success as being the result of luck. But the fact of the matter is that there are many parallels between short-term speculation in the stock market and gambling. Short-term speculation on any market is essentially a game of random chance. If daytraders make a bet on a stock, they're essentially guessing the stock will either go up or down. Since there are two outcomes, the odds are 50-50 that the stock will go up or down. That's exactly the same probability of hitting heads in a fair flip of the coin. This is assuming the market is efficient and that the investor does not have valuable inside information about the stock. And to answer your question directly, yes, if you sell a stock for a gain, that was a loss for someone else. Remember that there are only a certain number of shares outstanding of any company. That includes every company ranging from General Electric to XM Satellite Radio. If you buy shares, someone on the other side of the trade is selling them to you. If the stock rises after you buy it, you have taken a gain that would have belonged to the investor that sold the stock to you. Similarly, if the stock falls after you buy it, you are absorbing a loss the previous investor would have taken. But that doesn't mean investing is a zero-sum game. Statistics tell us that investors who invest in a diversified basket of stocks for the long-run almost always profit. During the 10 years between 1995 and 2004, the broad Standard & Poor's 500 index rose 12.1% on average per year, says IFA. So even though many investors won or lost on individual stocks during that time, the investor who owned a broad basket of stocks and held on to them would have enjoyed a nice gain."
Matt Krantz
Financial Markets Reporter at USA TODAY

I think the author makes most of the points about zero sum right on, but he misses some elements. All in all one of the better comments on the subject.

For more on the zero sum game read the zero sum whitepaper by Larry Harris and Chapter 3 of the book Trend Following.

Hedge Fund Belly Up; Lesson?

August 29, 2005

From a New York Times article yesterday:

"Marketing materials for Bayou describe Mr. Israel, 47, as a "third-generation trader" who has been trading since 1978. His was a short-term strategy in which he would rarely keep positions for more than three days. He was satisfied eking out small gains rather than making big, directional bets on sectors or industry groups. What Bayou does best, a recent investor note said, "is hit singles on a regular basis."

A hedge fund that "hits singles" goes bust? Surprise? No. For whatever reason many people think they are playing it safe by trying to get the so-called small consistent profits. Unless you are Jim Simons or Toby Crabel, great success in the "singles" game seems like a mirage.

Earl Weaver: Moneyball Man

August 28, 2005

From the Washington Post today comes a story about the "bunt debate" in baseball:

Earl Weaver

"As a future Hall of Fame outfielder in Baltimore, Robinson played for four seasons under Manager Earl Weaver (himself a Hall of Famer), who is widely considered the father of the anti-bunt movement. In his book, "Weaver On Strategy," the legendary skipper lists his "laws" of managing, the fourth of which is, "Your most precious possessions on offense are your 27 outs." Weaver's Fifth Law is a corollary: "If you play for one run, that's all you'll get." "I hated playing for one run," Weaver said recently. "But I didn't always take my own advice. I never bunted with Frank Robinson or Boog Powell or Eddie Murray at the plate, of course. But I did it with [Mark] Belanger and [Paul] Blair, two real good players. I think I bunted them too much."

Isn't that a great line? Play for one run and that's all you will get. There it is in black and white the "secret" to baseball or trading success. I also used a great line about Earl Weaver in my book Trend Following:

"Earl Weaver designed his offenses to maximize the chance of a three-run homer. He didn't bunt, and he had a special taste for guys who got on base and guys who hit home runs."

Trend following is always about the home runs. Think there is more safety in hitting singles (or short-term trading's small gains), think again.

Wizetrade™ v. Trend Following

August 27, 2005

Some claim that trend following trading is no different than the infomercial Wizetrade™. For those who do not know or those living overseas, Wizetrade™ is an infomercial running non-stop here in the United States. It promises clear "signals" for buys and sells. Wizetrade™ doesn't tell you how the signals are generated (it is a black box), it just tells you to buy on a "green" light and sell on a "red" light. This might sound very simple (and maybe plain stupid), but it is selling like crazy to those who think they have found a nice & easy alternative to buy and hold.

I don't see how trend following, as described in my book, is the same as the infomercial Wizetrade™. However, it makes me wonder that even if a strategy such as trend following is described in detail, can everyone get "it"?

NOTE: Wizetrade™ is a Trademark owned by GlobalTec Solutions, LLP. I have no association with Wizetrade™. We do not offer or supply Wizetrade™ products or services.

Economic Event Markets

August 26, 2005

Worth Magazine had some good insights on the new economic event markets such as Hedgestreet.com.

Article Part 1.

Article Part 2.

Also from the NY Times is another article about these new markets.

Know What He Knows

August 25, 2005

This paper from Flavia Cymbalista contains the following excerpt:

"George Soros does not offer an alternative particular cut of market reality, a different set of already defined factors. Instead, he operates with that which eludes any particular cut of market reality: intrinsic uncertainty. Rather than assuming a static order, Soros embraces the lack of fixed references in his guiding principle, the belief in fallibility, meaning both the belief in his own fallibility and the belief that the misconceptions and misunderstandings that go into our decisions help shape the events in which we participate."

I am not attempting to embrace all she says, but she does offer some very good points and great food for thought.

Land of the Lost

August 24, 2005

One of our favorite crazy critics sent another rambling diatribe in today. Most of his emails are plain loco, but some are useful to teach lessons.

Today "Mark" writes us:

Your headline today is priceless. It just begs the question: what makes you any different from the broker who works on commission?...At least at Morgan Stanley I have the comfort of knowing that my money is FDIC insured and with a reliable and established company. With you I get some phony stats, a "Holy Grail" and a really f**king expensive lesson on how to read moving averages."

Some quick thoughts for Mark:

1. I am providing education and commentary. Moving clients in and out of trades for the expressed purpose of generating commission is not my calling.
2. Morgan Stanley accounts are not FDIC insured.
3. Trend following stats in my book are not "phony". Those stats are on file with the United States Commodity Futures Trading Commission and or the Securities and Exchange Commission.
4. Trend following is best thought of as answering the five questions posed in chapter 10 of my book Trend Following. "Reading" a moving average, whatever that means exactly, does not constitute a trend following trading system.

Tim Knight of Prophet.net

Tim Knight, the founder of Prophet.net, offered the following words about my book Trend Following recently:

"I also wanted to suggest a book I finished reading yesterday - Trend Following. You can learn about it on Michael Covel's site. I have no affiliation with the author, but I think it's a terrific read. The web site is pretty interesting as well!"

More Commission!

August 22, 2005

Some feedback this morning from a former broker now launching his own fund:

"A few weeks ago I gave a broker that I used to work with a copy of your book [Trend Following] to show him that it is possible to make money trading. About a week later I spoke with him about it [and] was floored by his response. The only thing he wanted to know was, "how does this help me bill more commissions?" He just didn't get it...This really illustrates the lack of knowledge and responsibility brokers who work on commission really have for their clients."

Actually I think the broker who wanted to milk more commissions did get it. He realized my book would not help him to do that!

Spare $5000?

One of the favorite questions by beginners is, "Can I trade your system or invest with a trend follower with $5000?" Not sure where this number comes from, but it always seems to be the same $5000 for all beginners!

I noticed the other day that Ed Seykota was asked at his site Seykota.com (and I paraphrase):

"I have $5000...should I keep trading or stop until I gather equity to diversify?"

In true Seykota style he responded:

"Say you want to buy a car and only have a few dollars. I wonder if you: Go out and purchase something in your budget, like a spare tire (or) wait until you can afford to buy a whole car."

He then added:

Plan A:
Drive this around for a while.

Plan C:
Develop a trading system and attract capital.

Another long standing view on the "capital" needed to trade.

Fear and Loathing

August 21, 2005

While attending a party last night I was introduced to an executive. This man has traveled and lived throughout the world over a 25-year career. His academic background includes a MBA from a top US school.

He had been told that I had a book out about the "markets" and immediately started offering opinions even though he had no idea of the topic:

"So you make projections? I think forecasts are a bunch of shit."
"Economics are worthless as a science."
"No one has any idea which way the market will go."

After listening to 15 minutes more of the same thing but said a different way, telling him that I agreed did not seem to register. I then said my book was not about forecasts, projections and economics. He finally heard that. I tried to give a brief overview of trend following trading making the case that some serious money had been made beating the market averages for the last 30 years.

Without even asking follow-up questions he started talking about his investments across multiple mutual funds outlining their poor performance. He was already convinced that there could be nothing in a book that could possibly help. While these conversations are not much fun sometimes, they are always great reminders of why there will always be winners and losers in the market game. Big egos simply prevent many people from ever helping themselves.

Stan: Tyrannosaurus Rex Skull

Yes, it doesn't have anything to do with trading, but this page gives background on the Tyrannosaurus Rex imagery new to my personal blog site.

Price, Price, Price

August 20, 2005

A recent article I wrote for TradingMarkets.com.

Thoughts from the Old Pro

August 18, 2005

Suggestions for trading from the old pro and founder of Commodities Corporation Amos Hostetter:

1. Experience must teach. Follow it invariably.
2. Observation gives the best tips of all. Observe market behavior and experience shows how to profit.
3. Buying on a rising market is the comfortable way. The point is not so much to buy as cheap as possible or go short at the top prices, but to buy as & sell at the right time.
4. Remember a market is never too high for you to begin buying or too low to begin selling. Let your tape reading show you when to begin. After the initial transaction don't make a second unless the first shows a profit.
5. There is a great deal in starting right in every enterprise.
6. When something happens on which you did not count when your plans were made, it behooves you to utilize the opportunity.
7. In a bear a market it is always wise to cover if complete demoralization develops suddenly.
8. Stick to facts only and govern your actions accordingly.
9. What is abnormal is seldom a desirable factor in a traders calculations. If a market doesn't act right, don't touch it.

Commodities Corporation was the original trading mentor long before Richard Dennis and the Turtles. Commodities Corporation, as noted in my book, taught or funded many of the great market wizard trading pros.

A Good Listen

August 17, 2005

This presentation (MP3 audio) once given by Bill Dunn is interesting. It goes along with the charts in the book "Trend Following".

Bernard Drury

August 16, 2005

Bernard Drury, a top trader, took a typical not so typical route to trading success. An excerpt from Futures magazine:

"So, how does this Russian language major do it? Not surprisingly, he attributes his success to lots of hard work and a little good fortune. Just out of Dartmouth College, Drury took a job as a trader in the grain markets at the Minneapolis Grain Exchange thinking the international aspect of trading would put his Russian skills to use. Though he never needed to speak the language, he grew more interested in the trading industry. His next job took him to Washington, D.C., where he worked as a writer analyzing the grain markets and how agricultural policies affected them. For more than eight years, he watched the grain markets and learned to anticipate certain responses to news and events, a skill that would come in handy later. "I was eager to get back to trading. So in 1990, I moved back to Chicago to trade for myself," Drury says. It's no surprise that he stuck to what he knew and traded grain spreads. "It was serendipitous that I chose to study for the MBA while I was in Chicago because, as part of a class project, I did research on the managed futures industry," he says, describing how that in-depth look turned his attention to a new aspect of trading. "I am lucky I did that class project because it encouraged me to set up a CTA firm of my own."

Today, Bernard has left the fundamentals behind and is a successful trend following trader.

Turtle Bust: Learn A Lesson

August 13, 2005

A few years back a former pupil of Richard Dennis started touting his new money management firm. This man (who we will call "Bob") had never traded for profit except while under Dennis's guidance, so his nearly 20 year absence from the markets was greeted mostly with a yawn by the investment community. Nonetheless, "Bob" hooked up with a less than savory broker (who was fined shortly after the fund started) to raise money and started touting his trading prowess in chat rooms.

"Bob's" firm started their track record in Spring 04 and got up to $800,000 under management from client additions. Yes, even with a resume that connected with Richard Dennis, less than a million dollars was all that could be raised. At the end of July 05 that number was down to around $300,000 from a combination of extremely poor performance and hasty client withdrawals. Uh oh.

Of course, the markets have been up and down, but compared to his peers "Bob" has seemingly blown up. How can this happen? If you have all the trading rules in the world, but you are sloppy, lazy and a poor businessman with many failures behind you, trading failure is not exactly a surprise. I am still amazed that some people think that trading rules will repair poor character.

Interestingly, I had met "Bob" before, so none of this was unexpected. As one hedge fund associate commented to me recently, "I saw [his] recent numbers....game is over."

Lessons from the Loco #2

August 12, 2005

Sometimes it can be very educational to post comments from people that don't quite get "it". That said, more from yesterday's "angry" reader:

"Even more disturbing are the extreme lies in your "approach". Trend followers use "systems" and "money management" to make money based on momentum. They buy high and hope that there are enough suckers to buy higher. How can you describe that as sound investing? You make it sound like this is some form of intelligent investing. Like there is some rhyme or reason. There are no sound principles behind it. No intelligence. No reason. Just hold and hope and hope you get out before the crowd. Trend following depends on someone else being dumber than you. Buy high and hope someone else buys higher. It is nothing more than that...You sell a crummy irrational approach to investing that is no more successful than most mutual funds. You are no different than the people you bash every day."

He also added in email to me:

"You don't even understand the roots of Trend Following. Ask the pros if they believe in an efficient market? They will most likely say that the market is inefficient (how can they beat an efficient market?) and therefore predictable (for trend following to work the market MUST be inefficient). But if the market is inefficient (predictable), then why do your "pros" use a theory/system that relies on unpredictability?"

I understand what he is saying in his first quote above (and yes he has no clue about what he speaks), but can someone decipher the second quote?

Once again, if anyone else out there has this view of trend following trading after reading my book, I would like to hear from you.

Lessons from the Loco

August 11, 2005

I have a reader who really seems to hate and not understand trend following trading at the same time. One of his comments tonight:

"In the market, everything works and nothing works. If you use Trend Following then you rely on other people being dumb enough to buy after you. It is nothing more than that. And some times you will get lucky and some times you won't."

If anyone else out there has this view of trend following trading after reading my book, I would like to hear from you.

Larry Hite

August 10, 2005

From Trader Daily a good quick and dirty bio on Larry Hite:

"As a visually impaired, scholastically challenged kid growing up in Brooklyn, Larry Hite was never voted most likely to succeed -- he didn't even learn to read until the fifth grade. Only toil and sweat could have propelled the scrawny kid to greatness, and toil and sweat were out of the question. "I didn't want to work for my money," Hite, 64, says unapologetically. "I wanted money to work for me." His game plan worked. The ideas Hite concocted in the 1970s and '80s spawned empires and industries: Man Group, PLC, might not be the beast it is today -- it's one of the largest hedge-fund managers on the planet -- had it not collaborated with Hite two decades ago on a revolutionary joint venture. Likewise, Hite forever changed futures trading in 1972, when he published a paper titled "Game Theory Applications" in The Commodity Journal, helping to usher in a new kind of quantitative speculating that masters such as Jim Simons now practice."

No Prediction

August 08, 2005

From Investopedia a good excerpt on prediction follies:

"One of the greatest popular myths about investing in stocks is that in order to be successful, you must be able to predict the stock market's movements. Why do people assume this? For some, it is because they do not understand that stocks give a positive and substantial return over time - they falsely assume that stocks bounce around in the same range forever, and they therefore conclude they must predict movements in order to be able to sell at the top of the range and buy at the bottom of the range. For others, the desire to predict is borne out of human nature, which puts a premium on certainty. We love to know what will happen in advance. Hence, it is usually assumed by the beginning investor that to be successful, one must first become an expert at forecasting future market trends. Experienced investors know, in fact, that nothing could be further from the truth. Some icons of Wall Street love to advance the cause of market predicting, because they are paid to predict these movements. Others simply humor their clients who are looking for market projections because they know that it is easier to give them a projection than to try to correct the clients' thinking. For instance, nearly every retail brokerage firm has a chief economist or market strategist whose main responsibility is to predict the climate for stocks. A large number of books, advisory services, and such that are sold focus themselves almost exclusively on prediction of how the stock market in general will perform in the future. But in truth, the best way to make money in the stock market is to avoid approaches that rely on market predictions. This will most likely seem an odd or even a absurd statement to some, perhaps most. Yet, any serious review of the results of market gurus over a long period of time reveals a track record that is no better (usually worse than) a simple buy-and-hold strategy. Don't misunderstand me: There is no doubt that if a person could accurately predict the short-term fluctuations of the stock market, that person could far exceed the return of someone who simply bought a basket of stocks and sat on them. However, the one fatal problem with this is that there has never been a single person who has figured out how to do it. Nearly all market advisors claim to be able to call the market's every turn, but in fact every credible study ever done on the subject has proven that these claims are invariably false. By far, most market prognosticators significantly underperform the market, despite their universal claims to the contrary. Given the large number of market gurus that now exist, the laws of statistics dictate that some of them must beat the market, out of pure luck if nothing else. However, they lack the ability to repeat this performance from one time period to another, and the group of market beaters will usually be a different group every time period that is sampled. If you could predict which guru would be right for the next year, you would be in good shape. But, of course, it's just as hard to predict which guru (or which dart board) will be right for the coming year as it is to accurately predict market conditions. Finally, even if we are generous and assume that there is some market forecaster out there who has the holy grail of market prediction, our chances of being able to sort him out from those who simply got lucky are pretty slim."
Investopedia

Interesting Radio Ad

August 07, 2005

While perhaps too "salesy" for me, this radio ad from Hedgestreet continues to move their innovative exchange forward.

Catch Some Falling Stars

August 05, 2005

I was scanning Yahoo Finance today for some typical fundamental commentary and boom there it is from the Motley Fool:

"Some days, you have to love the market. Like today. Yes, I'm one of those people who, perversely enough, has a big appetite for red. That's because I love getting shares on sale, and I think there might be a few good bargains appearing today. Despite good-looking sales results, a lot of fine retailers are taking their lumps. Case in point: American Eagle Outfitters. It has dropped like a rock over the past few days, including this morning, apparently owing to Street dissatisfaction with July sales and earnings guidance. What's bunching the schizoids' undies today? Horrors! It's same-store sales growth of 17% and overall sales growth above 25%. Oh, and charge them with the further crime of lifting earnings guidance into the range analysts were expecting. You'll excuse me if I laugh openly at the people running screaming for the exits, especially given the trajectory of American Eagle's margins, free cash flow, and dividend. (Hint: The direction is up.)"

This all sounds like great fun. But doesn't it also sound like the typical banter so common not but a few years ago during the dot com bubble? If the trend of the share price is up, you are long. If the trend of the share price is down, you are short. If you find this kind of fundamental commentary from Motley Fool insightful please be kind enough to tell me how you use it to your advantage.

Seykota on Backtesting

August 03, 2005

"Back testing can help you experiment with various methods for trend identification and risk management until you find some combinations that suit your temperament. Any back testing you do, and any subsequent trading you do, all occur in the moment of now."
Ed Seykota

United's Pension Folly

August 01, 2005

Workers at United Airlines accepted many years ago that their company would look out for them. United supposedly had a great pension plan. As the New York Times recounts, it all imploded.

Who is ultimately responsible? If anyone involved did anything illegal, they are responsible for illegal actions. But if the workers of United simply trusted that everything would be done the "right way" for their retirement and it wasn't, they must accept the blame for buying into a flawed scheme.